Like Greece & Ireland, IMF Shouldn't Help Portugal

Now I'm hopping mad! I know that I'm beginning to sound like a broken record on this, but in the interest of fairness, I will fight the good fight even if no one else will do so. Bravely I must soldier on in this bleak and unbearable world. Previously, I have argued that the IMF should not have bailed Greece out because its problems were primarily of the fiscal sort (accumulating a debt too large to service), not the balance-of-payments sort (having insufficient foreign exchange to pay for necessary imports like food and energy).

I've also said that bailing out Ireland was an indecent financial proposal since its woes stem primarily from the state guaranteeing its banks' solvency without fully realizing the magnitude of such commitments. Insofar as the IMF remains an institution dedicated to dealing with balance of payments problems, we have an identical main problem with IMF lending to Ireland and Portugal. While theirs are somewhat dissimilar woes, what they have in common with Greece is not having a BOP problem which would oblige the IMF to act according to its Articles of Agreement.

Even the IMF describes its activities in Ireland as support for recapitalizing nearly insolvent lenders which have, in turn, tested the solvency of the Irish state. Witness:

Ireland’s banks are at the heart of the current crisis. Massive lending during the boom years left banks heavily exposed to the Irish property market, which has yet to stabilize despite a steep fall in housing prices of 36 percent since the peak in 2008. At the height of the boom, the assets of domestic banks amounted to five times Ireland’s gross domestic product, with real estate loans making up close to 30 percent of all loans in 2006.

Such an oversized banking system is no longer sustainable, not least because of the ongoing weakness of the property market in Ireland. The problems have resulted in a loss of deposits and market funding, and have made Irish banks overly dependent on financing from the European Central Bank. The banking sector therefore needs to be restructured and recapitalized.

There isn't even an allusion to balance of payments woes, precisely because Ireland doesn't suffer from them.

And so it is the case once more with Portugal. Sharing a common currency with its main trading partners in the Eurozone, the euro is also a standard global reserve currency that is second only to the US dollar in terms of reserve holdings. But Portugal may have trouble obtaining euros, you say? As late as February, the ECB had a facility for purchasing sovereign issuances which it used to help out Portugal. So, Portugal could have just issued more IOUs and sold them to the ECB:

The European Central Bank has intervened in eurozone bond markets for the first time in weeks, buying Portuguese debt amid fears that the country could yet seek an international rescue. The ECB returned to the market on Thursday as Portugal’s cost of borrowing on 10-year debt jumped to a euro-era high of 7.63 per cent, traders said. The ECB temporarily suspended its bond-buying programme in mid-January.

The real triggers for Portugal asking for help from the European Financial Stability Facility (EFSF)/IMF are a nuber of things. First, the outgoing PM Jose Socrates failed to pass austerity measures, displeasing powers-that-be in Brussels who had hoped Portugal could avoid another massive bailout episode. Absent political leadership (Socrates resigned and there will be parliamentary elections come June 5) and a credible plan for getting its fiscal woes under control, the ECB inevitably tired of purchasing Portugese debt as a lifeline and asked Lisbon to formally ask for help. Financially, servicing EUR 10B of maturities due in June is virtually impossible. Hence the cry for mercy.

My argument in the Portugese case is similar to the Greek one: In the main, fiscal woes--overindebtedness--is to blame, not BOP problems. Although the IMF may be giving its support to Eurozone countries to help quell systemic disturbances in the international monetary system, that isn't what it was tasked for as I keep repeating.

It's also a matter of fairness to LDCs. Most likely, poor countries aren't contributing to the IMF so that their funds will be used to bail out rich countries suffering not from BOP problems but from fiscal ones. So, not only is it a misallocation of funds, but also a miscarriage of global governance. By all means, let the Europeans help out one of their own--but without IMF funds.

The world is an unfair place, but it was like that long before I got here.

Is the US Really More £$%*ed Up Than the UK?

With the US heading towards a government shutdown by Friday lest they feed the whole unsavoury enterprise more scraps, let's just say that the UK at least has this one over its erstwhile wayward North American insurrectionists. (As if cutting a measly $73 billion from a trillion-plus dollar deficit helps much.) I have heartily endorsed the idea of US government shutdown [1, 2]. However, another less gung-ho opinion is that of Emma Duncan, deputy editor of The Economist. In her op-ed, she says that the UK is in the least of a political-economic pickle amongst the US and EU. For, the UK political system is not geared towards inherent intractability (American "checks and balances") or making a challenging economic compromise work politically (a single currency). Although I am not entirely in agreement, there are interesting points worth mulling here.

There's the obvious reference to free lunch economics where America is buying fleeting respite from tomorrow's inevitable misery as the US authors its own demise:

America's problems are quite different. Its government has been spending freely to pump demand into the economy, and its central bank, the Fed, has been keeping interest rates at rock-bottom and printing money like there's no tomorrow. At more than three per cent a year, America's growth rate is therefore, not surprisingly, rather healthy.

It's not so much economics as politics that's gone wrong in America. Washington is being torn apart by battles between the Democrats and Republicans. They cannot agree on a budget for 2011, despite many concessions offered by the Democrats, for the Republicans are being dragged further and further Right by a fervently anti-government Tea Party wing. If the two sides cannot reach an agreement before Friday, the government will run out of money, and civil servants and suppliers will stop being paid.

Sooner or later, of course, they will agree on a budget. But that will solve the short-term difficulty, not Washington's much larger, longer-term problem. The government's massive commitments on pensions, healthcare and the like, combined with a deep American reluctance to pay taxes, mean that the country is slowly going bust. It can keep borrowing for the moment, because the dollar remains the world's favourite currency and American treasury bonds have long been regarded as the safest place for companies and governments to put their money, but unless America can sort out its budget problems, that won't last.

And then there's her argument of why Britain is better placed to avoid American-style unreality:

In Britain, the Government has put together what sensible people in Washington can only dream of: a plan for getting the Government's finances under control. It isn't much fun. For the public sector, it means less generous pensions and fewer jobs. For the private sector, it means less revenue and less profit. For everybody, it means higher taxes - a VAT rise in January and a National Insurance increase this month. Growth is creeping along at a rate of around 1.6 per cent. But the markets are sufficiently impressed that, although our budget deficit rivals Greece's, our borrowing costs are barely above Germany's.

Britain is doing better than either America or Europe not because our politicians are cleverer but because the way our country is run makes sensible economic management easier. America is stuck because its political system is designed to put a brake on politicians' freedom of action. Power is shared between the President and the two houses of Congress. If they disagree, there is stalemate - and, as the Republican Party hares off to the Right, they disagree more and more.

British governments, by comparison, can turn on a sixpence. Lord Hailsham, the brilliant lawyer who became a Tory Lord Chancellor, called it an "elective dictatorship". It lets prime ministers do pretty much as they like, as quickly as they like. That's not always a good thing - but it's a great advantage when dealing with a crisis.

I certainly hope she's right...

Why I Still [Heart] Trade War, US Federal Shutdown

I've just come from an engaging talk by Martin Wolf at the LSE. In his take on one of Aesop's fables, China and other industries have been, in recent years, industrious "ants" busy saving up through thrift and industry. Meanwhile, the likes of the US and the UK have been loafing around, singing a happy tune. Making his own elaboration, he adds "locusts" or financial intermediaries we've come to know more than we would probably like in the aftermath of the subprime crisis who perform the task of intermediating between the "ant" and the "grasshoppers."

Depressingly, Martin Wolf lays out a global picture which is remarkably unchanged despite the aforementioned crisis (the podcast should be uploaded to the LSE Events site in the next few days for you to listen to). Various LDCs have now accumulated an unbelievable $9 trillion in reserves by his estimate after slowing down their rate of accumulation in the immediate wake of the US-manufactured debacle. Speaking of whom, the Americans have been acting like themselves in acting out the ol' "deficits don't matter tune"--lip service aside, no one has the political will in that dissipated land to do anything about it.

This brings me to something I wanted to ask of Wolf but ran out of time: We've been talking about global economic imbalances since 2003 or 2004 and how increasing savings in places alike the US (making them more "ant"-like) and increasing consumption in the surplus countries alike China (making them more "grasshopper"-like) should help mitigate these imbalances. Well, it hasn't happened. Despite the novel analogy, the facts remain largely unchanged.

It seems to me that we need to shake both parties out of their complacency. How can that happen? Again, I can think of two ways that global economic imbalances can be mitigated in one fell swoop:

First, a nice US-China trade war should solve the problem of capital flowing uphill from where there are more investment opportunities (the PRC) to where there are less (the US), hence investment in non-productive activities alike residential fixed investment. No capital flows, no imbalances, period. I've been quite keen on this confrontational approach of the US and China just cutting the crap and putting their money here their mouth is at for quite some time now.

Second, a newer idea is inspired by the current congressional budget impasse in Washington. While bickering over $61 billion worth of cuts is quite pointless insofar as the US will most likely run a deficit well over $1 trillion next year, look on the bright side: Republicans are threatening to stop drip-drip-drip feeding Washington and let the federal government shut down. In reality, of course, only a few government agencies will stop, leaving the diplomatic service and other apparatus of American influence running. Still, you can imagine a prolonged "starve-the-beast" episode where intractable differences drag on, causing massive hits to confidence in America's ability to run day-to-day.

Two attractive scenarios obtain here in the interest of solving global imbalances: (a) the US becomes unable to service its gargantuan debts and hence defaults on "AAA" Treasuries, causing massive investor panic among those dumb enough to hold such dollar-denominated detritus; or (b) investor fears over hampered debt service ability owing to significantly diminished revenue collection makes folks shun US sovereign debt in droves. Voila! Cutting off funding to the world's largest issuer of such instruments solves the problem of reserve overaccumulation overnight.

Wouldn't it be nice? Martin Wolf has been talking about the resolution of global economic imbalances for a very long time now, but to no avail. So, our American friends, write to your senators and congresspersons about how much a blanket tariff on all Chinese imports is necessary, or how a federal government shutdown is required to show the world conservatives mean business. Maybe the Tea Party won't be so bad if something along these lines pushes through.

Besides, ain't it about time we figured out who's got the biggest balls in today's global economy?

China Shows Its G-20 Might, Wins on Imbalances

In case you missed it, and I can't blame you if you did because it mostly consisted of theatrics as opposed to anything substantial, the G-20 convened a meeting on the question of global economic imbalances over the weekend in Paris and issued a tame communique. Instead of having a substantial bearing on such imbalances, however, it casts more insight on that perpetual question of "Hu's the daddy of the world economy?" Coming into this meeting, the Chinese position was already well understood on the matter of using indicators for imbalances. Which is to say that overall the lesser, the better. At the meeting proper, the PRC held firm in the face of near-universal clamour for using such indicators to prevent another 2008:

China is the only country blocking an agreement on a set of indicators to measure global imbalances, leaving deputies with a limited number of options to present to ministers on Saturday, a G20 official said. The official said G20 deputies had drafted a list of two sets of internal indicators--public debt and deficits and private savings--and two sets of external ones--the current account or trade account as well as reserve levels combined with real exchange rates.

"China is reticent, generally speaking," he said, noting Beijing preferred to include the trade balance rather than the current account. "And its position on reserves and the exchange rate is well known," the official said. China's opposition had left G20 deputies with limited options to suggest on Saturday: either accept the four indicators or reject them; introduce a hierarchy where some indicators count more than others or use a time delay for their gradual introduction, the official said.

Among the Europeans, the Germans were holding out for some Chinese hide:

Germany dug its heels in ahead of G20 talks on global economic imbalances on Friday, with a German source saying Berlin wanted nothing less than agreement on a full list of indicators used to tackle such mismatches, including exchange rates. G20 finance ministers meet in Paris on Friday evening and Saturday to discuss a series of indicators that could be used as benchmarks for judging when one of other of the world's economic powers should change economic policy.

Meanwhile, the Americans brought their usual sob story to the table [quick, bring me a hankie], albeit with some additional flourishes given the wider audience of G-20 member countries. They probably thought a message of "China hurts everyone including fellow LDCs" would have added resonance:

Treasury Secretary Timothy Geithner on Saturday pointed to the problems China's tightly controlled currency poses for other developing economies and said Beijing still had further to go to let its currency rise. Talks at a Group of 20 meeting in Paris centered round efforts, led by Germany and G20 presidents France, to persuade China to include its yawning current account surplus and undervalued currency in a list of measures aimed to start a process of rebalancing the global economy.

There was little public evidence that the United States itself had pushed Beijing hard on that issue, but Geithner reiterated that there was still some way to go in the steady appreciation of the yuan. "China's currency remains substantially undervalued, and its real effective exchange rate -- the best measure to judge its currency against all of its trading partners -- has not moved much in this latest period of exchange-rate reform," Geithner told a press conference after the meeting.

When all was said and done, let's just say China largely got its way at the G-20. Although not necessarily a positive outcome, it goes to show you how the PRC's influence now looms large at these international confabulations. Not only was there any mention of currency reserves in the final communique, but the rest of the terminology was watered down to the point of, well, being back to where we were before. There too was no mention of REER (real effective exchange rate) being used as an indicator as per Geithner's overtures:

The Group of 20 dropped currency reserves and provided compromise wording on other indicators in a list of measures it will use to assess global economic imbalances, a post-meeting communique showed on Saturday. The deal, struck after two days of deadlocked negotiations in Paris, gives ground to China, who had resisted the inclusion of reserves and the current account balance in the list [it favoured using the trade balance].

There was no mention of reserves and rather than the current account and real effective exchange rates, the group agreed to use "the external balance composed of the trade balance and net investment income flows and transfers, taking due consideration of exchange rate, fiscal, monetary and other policies."

Try and make that mishmash of weasel words stick. You can't identify transgressors as there are no hard and fast indicators of exchange rates, fiscal and monetary policies that would identify a nation due for adjustment. Again, read the communique and weep.

Bottom line: Why don't they just give China enough policy space to figure out what it already understands on its own? Attempts to gang-tackle it at international summits clearly haven't worked, and the latest G-20 gathering is no exception. In fact, my argument is that others bloviating about currencies and reserves only makes matters worse by raising Chinese resistance. Generally, states (except for the weakest ones) do not welcome the image of being cowed by foreign nattering nabobs of negativity. What more China?

Behavioural Economics? Try Biological Economics

By now, all and sundry should be familiar with behavioural economics. In contrast to homo economicus or rational economic man, real humans are subject to all sorts of foibles during decision-making processes. This body of work was most memorably crystallized in Kahneman and Tversky's prospect theory which won a Nobel Prize in Economics a few years back. If anything else, the idea of "bounded rationality" was visibly displayed by the easy fallibility of financial services workers of all stripes during the subprime crisis.

Although behavioural economics is now rightly drawing its share of adherents, there is yet another emerging field that may help our understanding of international finance in particular. No, I am not talking about neuroeconomics, though that too is an interesting area. Rather, we may be on the verge of mainstreaming what was previously esoteric in biological economics. Drawing on natural phenomena, there may be patterns in how financial markets operate that can be understood thusly. Instead of building models on faulty notions of homo economicus, how about building models drawing on nature? Lest you think this work is too high-faluting, the Bank of England has begun sponsoring work here. From Auntie:

Biology and the natural world are helping economists build new models to understand the dynamics of the financial sector and why the US sub prime loan crisis caused so much global damage. Could an understanding of ecology have helped prevent the credit crunch? It sounds unlikely, but a group of scientists working with the Bank of England believe banking has lessons to learn from biological science...

As the financial sector grew, so did the demand for talented, numerate graduates to create new and ever more sophisticated products. But the financial sector became too tangled and when the crash came, it threatened to bring down whole economies. "This was not something that our conventional models could make sense of," says Andrew Haldane, executive director of financial stability at the Bank of England. "Activity in every country around the world fell off a cliff," he says. But there was one group of people who could make sense of it.

Enter the biologists. Scientists and the Bank of England have begun to explore possible insights from the life sciences. Comparisons are being drawn between biological systems, with their complicated webs of interactions between all the different species, and with the interactions between different banks and financial institutions. "We need to think about the system as a system, rather than looking at this atom by atom, or node by node," says Andrew Haldane, admitting that pre-crisis, this had not been done. We didn't differentiate between the big and the small, we didn't really think hard about the joins between them," he says.

Until now, system-wide data collection in banking has been virtually non-existent. Regulators are hoping they can gather information to allow them to map the financial web, and spot fluctuations that could lead to an institution collapsing. Seeing banking as a biological system can also help explain why the financial world became so vulnerable.

Paradoxically, as banks grew bigger and more complex, the financial system as a whole ended up being more homogeneous. "It's rational for an individual bank to have sought to diversify its balance sheet," says Haldane. By taking on different functions, a bank spreads its risk - it is not putting all its eggs in one particular financial basket. But all the big banks were doing the same thing. "The quest for diversification by individual banks, led to the system as a whole rather lacking in diversity," Haldane says.

In biological science, a lack of diversity in a population equals a lack of robustness - and this has fuelled calls to break up the big banks following the credit crunch. Another approach is to look at the spread of disease through a population by drawing on the parallels between big banks, and the epidemiological concept of a "superspreader" - an individual who, through their contact with large number of other people, is responsible for the spread of an infection. Like the spread of an infectious or sexually transmitted disease, the crisis that struck the biggest banks had a knock-on effect to the other institutions connected to them.

"For the equivalent of the promiscuous, we have these big banks globally who have interconnections with all the other banks in the system," says Andrew Haldane. "What you need for those types of entity is a greater amount of protection up front," he says.

In banking terms, that protection requires that the interactions between institutions are kept from being so convoluted that when there is trouble, everything goes wrong at once. The challenge is how to do that in practice, streamlining interconnections and maintaining diversity.

Don't dismiss it out of hand. If it adds to our explanatory power of global financial machinations, then all the better.

When Basel III Met the Yankee Bubblemeisters

In German, weltmeister is the world champion in English. But, when it comes to inflating asset price bubbles, perhaps we can relax the rules of grammar and syntax and declare our American friends the global bubblemeisters. Not being content with one housing bubble and its demise, let's just say the US in its own inimitable way is trying to inflate another one via shenanigans such as the $600 billion Fed bond purchase programme.

Now we come to another conundrum of international organization in the form of the upcoming Basel III macroprudential banking regulations. Interestingly enough, some of its framers propose including a mechanism for various countries to report that asset bubbles are afoot at home. In theory, the others would then be able to raise financial firms' capital requirements to guard against troubles in the said country spilling across borders via this early warning device.

It sounds great in theory, but what if the world's largest economy is so magnificently distorted already by, say, still-historically elevated housing prices as to preclude rational analysis in neat and tidy Basel III frameworks? Beats me, and nobody should be surprised to see the bubblemeisters push back at the global negotiating table for Basel III:

Banking regulators have quietly taken a major step towards harmonised global regulation by agreeing to raise worldwide capital requirements whenever an individual country declares a credit bubble. Part of the larger “Basel III” banking reform package, the “countercyclical capital buffer” heralds a step change in the way national banking regulators interact and is the first concrete example of “macroprudential” regulation that seeks to moderate the economic cycle.

In a nutshell, it works this way:

The agreement, struck last month, says that if a country decides its economy is overheated – based on the ratio of credit to gross domestic product – it can require banks within its borders to hold extra capital against potential losses. Regulators in every other country would have to follow suit and impose a proportional surcharge on their own banks, based on the size of those institutions’ exposure to the bubble country.

However, there are operational problems in verifying that the concerned developed countries apply these measures equally. There's a particularly large one that may feel it's being unfairly targeted based on its recent economic history. Its excuse is that their geographical spread is so large that so-called bubbles may be localized as to render such measures impracticable (as if Michigan compensated for Nevada circa 2007, but I digress):

Banking groups said they were concerned some nations would impose buffers more readily than others, creating an uneven playing field. They are also sceptical that once buffers are imposed, they will become permanent, either because regulators never cut them or investors react badly to a reduction.

“A country would have significant disincentives to impose the countercyclical capital buffer [because] ... the impact would likely be greater on its economy than on the banks,” said Greg Lyons, a US partner at law firm Debevoise. The US is said to be particularly reluctant because it would have to declare a country-wide bubble, even though there might be large variations between regions.

In essence, what if certain countries deliberately encourage such bubbles for short-term gain alike certain folks whose, ahem, "forward-looking perspectives" incorporate nearly infinite discount rates?

PIGS? With Belgian Breakup, Perhaps PIGS-FW

Here's something that may have been overlooked in all the current brouhaha over troubled eurozone peripheral economies Portugal, Ireland, Greece, and Spain. With two bailed out (Greece and Ireland) and one allegedly being forced to feed at the trough (Portugal), there may be another in dire straits. You see, longstanding differences between the Fleming (Dutch) and Walloon (French) sides of Belgium's--how should I describe it--conurbation have been pronounced as of late, with neither side able to establish a majority in an impasse which threatens to surpass the crusader paradise of Iraq for the longest period on record after general elections without a government of 234 days. Such political strife is causing yields on Belgian sovereign debt to begin mirroring the fate of its unfortunate neighbours. The telltale signs are there, including pricier credit default swaps. From Bloomberg:

Belgium’s political leadership cast about for solutions to the impasse that has left the country without a full-time government and pushed up the costs of servicing Europe’s third-highest debt burden. Belgian bonds fell for a third day as the failure to restart seven-party [count 'em!] talks to form a government almost seven months after inconclusive federal elections heightened the risk of a downgrade in the country’s sovereign-debt rating.

“We’re back into a serious crisis,” Elio Di Rupo, head of the French-speaking Socialists, the second-biggest force in parliament, told RTBF television late yesterday. “People have really had enough -- this situation is intolerable.” The constitutional feud between the Dutch-speaking north and Francophone south leaves Belgium with a caretaker administration to confront the budget deficit as concern mounts that Europe’s sovereign-debt crisis will escalate.

Belgian 10-year bond yields rose 7 basis points to 4.14 percent at 6 p.m. in Brussels, pushing the extra yield over German bonds up by 11 basis points to 126 basis points. The spread, a gauge of the risk of investing in Belgium, has risen from 79 basis points on election day June 13.

King Albert II was pondering how to pick up the pieces two days after two parties in Flanders, the richer northern region, rejected a compromise designed to lessen federal powers and restart coalition talks that broke down on Sept. 3. The author of the compromise, Johan Vande Lanotte, a Flemish Socialist, yesterday asked to give up his role as political troubleshooter. The king declined to let him go, saying in an e-mailed statement that the next royal move is “on hold” until the mediator is summoned back to the palace on Jan. 10. “There isn’t sufficient readiness to start the negotiations,” Vande Lanotte told reporters in Brussels late yesterday. “You can lead a horse to water, but you can’t make it drink.”

Standard & Poor’s Ratings Services said last month that the longest-ever post-election stalemate in Belgium -- now at 208 days, surpassing the 194-day marathon of 2007 -- may lead to a cut in the country’s AA+ credit rating. Belgium’s debt was 98.6 percent of gross domestic product in 2010, trailing only Greece’s 140.2 percent and Italy’s 118.9 percent among the 17 countries using the euro, according to European Commission estimates.

Political leaders began considering new formulas for forging a governing coalition, including by widening the circle of parties involved in how to manage the linguistically split country of 10 million people that is home to European Union and North Atlantic Treaty Organization headquarters. The clash boils down to “who’s in favor of the end of Belgium,” Jean-Michel Javaux, co-leader of the French-speaking Greens, said on RTBF.

Bart De Wever, head of the Flemish nationalist N-VA party, the top vote-getter in the June election, sought a face-to-face showdown with Di Rupo, whose Socialists are the dominant force in the French region. “The moment has come for the leading actors to sit together and agree on a path forward,” De Wever said on VRT television. He said he isn’t calling for new elections or the breakup of Belgium. For his part, Di Rupo offered to include representatives of the French-speaking or Dutch-speaking Liberal parties in the quest for a compromise, meeting a longstanding demand by the Flemish nationalists. “We are open to every form, every formula for a coalition of democratic partners,” Di Rupo, who led the first failed bid to corral the seven parties into a coalition, told RTBF.

Flanders has gradually gained more clout in five constitutional overhauls in four decades, as its growing wealth surpassed the sunset industries that concentrated power in the French region for more than a century after Belgium’s founding in 1830. Home to companies such as Anheuser-Busch InBev NV and the Antwerp port, Flanders generates annual output per person of 31,067 euros, according to 2009 figures. Wallonia, the French- speaking south, is weighed down by the legacy of coal and steel industries, with output per person of 22,868 euros.

The immediate focus is on how Belgium will save an additional 1.8 billion euros ($2.3 billion) to meet an EU target of cutting the deficit to 4.1 percent of GDP in 2011 from an estimated 4.8 percent last year. De Wever rejected the setup of an emergency cabinet, saying it would be nothing more than “minding the shop.”

The deadlock made it more expensive for investors to insure holdings of Belgian bonds. The cost of insuring Belgian debt against non-payment for five years, using credit-default swaps, climbed 14 basis points to a record 249 basis points today, according to CMA prices in London. A basis point on a contract protecting $10 million of debt is equivalent to $1,000 a year.

So, to recap:

• The Flemish side wants increased political clout commensurate with their growing economic power compared to their Walloon brethren;
• The royals want this over and done with (to keep Belgium and the throne intact), but the multitude of parties don't want to play along just yet;
• The top vote-getting party, the New Flemish Alliance, may yet doggedly pursue its electoral pledge of independence;
• And if Belgium does break up, who'll pay for previously issued Belgian sovereign debt?

It's very interesting stuff and comes on top of similarly unsettling developments elsewhere. All I can say is that they'd all probably be better off papering difficulties for now while a bond crisis is in full effect in Europe. With a debt load about equal to GDP, the margin of error is slight. What goes around comes around: it used to be the French side that looked down on the poorer Dutch, so in the interest of historical accommodation, the latter may now have to accommodate the former.

Markets Ponder China Bailing Out Europe (Again)

OK, OK, so I am using the term "bailing out" in a very loose sense: For instance, China has not quite said that its continued patronage of US debt in the wake of the financial crisis is specifically to bail out America. Rather, it's always couched in diplomacy-speak such as preserving "stability" in the global financial system as a certain Yankee diplomat-beggar would put it.

I almost missed the clip above of LSE IDEAS' very own Niall Ferguson arguing that the Chinese should help bail out China on Fareed Zakaria's GSP programme. (Despite what our school paper says, he does work here.) This theme has been a continuing one: former IMF Chief Economist Simon Johnson even went so far as to suggest its headquarters should be in Beijing if and when the Chinese become the largest shareholders. Somewhat less far-fetched, China has indeed voiced support for the idea of diversifying its holdings by purchasing sovereign debt of troubled eurozone members (which ares still denominated in euros).

So it is that newswires are abuzz with news that the Chinese are once again making noises to similar effect:

China has promised to take further “concerted action” to support European financial stabilisation, including continuing to buy the bonds of countries at the centre of the sovereign debt crisis, according to senior European officials. The officials, who declined to be named, said Wang Qishan, a Chinese vice-premier, had given assurances that China would step up support for European stabilisation efforts “if necessary”. Mr Wang made the pledge during the third annual China-EU High Level Economic and Trade Dialogue, held in Beijing on Tuesday...

In addition, Klaus Regling, the head of the eurozone’s €440bn ($577bn) bail-out fund, said China had shown enthusiasm for bonds issued by his agency, tasked with raising a sizeable chunk of the funding for the €85bn Irish bail-out. The EU is China’s biggest export market, with two-way trade valued at $434bn in the first 11 months of this year, and Beijing has a strong interest in supporting regional stability. “From the European point of view we appreciate the support of China for the European and international effort to safeguard financial stability in Europe,” said Olli Rehn, European Commissioner for Economic and Monetary Affairs.

Two things, however: so the Chinese have already voiced support for troubled eurozone economies, but that hasn't done much to reduce their interest rate differentials over that of German debt. Also, further support is likely to be tied to the EU moving on two longstanding grievances China holds with the West over lifting its designation as a "non-market economy" earlier than 2016 as agreed to in its WTO accession and limitations to its purchases of European arms:

Mr Wang’s comments boosted the euro’s value against the US dollar, but China’s public support for Greece and Portugal over recent months has not prevented their bond yields remaining near record highs. European officials said that although China had not explicitly linked its bond purchases to any specific issues, Beijing asked in the talks for the EU to grant it “market economy” status and lift a long-standing arms embargo.

That said, I gather that market commentators are taking somewhat increased risk appetite as a result of expectations for China to backstop Europe. Once more, it's interesting how much market participants now attribute to China's actions despite limited evidence of it buying distressed euro-denominated sovereign debt.

Maybe LDCs Aren't Being Inundated w/ Capital (Yet)

The general impression you get from certain developing countries is that easy money policies emanating from reserve currency-issuing ones like the unbelievably profligate United States are driving up their exchange rates and threatening to inflate various bubbles. It may be some surprise that, in 2009 at least, this scenario did not really happen as capital flows to the developing world fell from 2008 according to a just-released World Bank report:

Net global capital flows to developing countries fell 20 percent in 2009 to $598 billion (3.7 percent of gross national income [GNI]), from $744 billion in 2008 (4.5 percent of GNI) and were a little over half the 2007 peak of $1.11 trillion. This according to a new comprehensive dataset launched by the World Bank today on international capital flows titled “Global Development Finance 2011: External Debt of Developing Countries,” which reveals the impact of the financial crisis on 128 developing countries.

Global private flows (debt and equity) declined by 27 percent in 2009 despite a rebound in bond issuance, portfolio equity flows, and (mostly trade-related) short-term debt flows. Foreign direct investment (FDI) inflows across the globe fell 40 percent, to $354 billion - their sharpest drop in 20 years. All the largest recipients of FDI saw net inflow declines in 2009. Net debt flows from private creditors dropped by 70 percent from $182 billion in 2008 to $59 billion the following year, driven by the collapse in medium-term commercial bank lending to public and private borrowers.

Reflecting increased support to developing countries during the crisis, net capital inflows (loans and grants) from official creditors increased by 50 percent to $171 billion in 2009. This was driven by a sharp rise in gross disbursements on new loans extended by the international financial institutions. These rose to $98 billion (from $61 billion in 2008) in calendar year 2009, of which $31 billion came from IBRD and IDA, the highest in the history of these institutions.

It will be interesting to study the implications here when the 2010 figures come around: Did repatriation flows to distressed Western firms temporarily reduce capital flows to the developing world? Or, did the effects of free money policies kick in after a lag--especially once everyone recognized that countries like the US had no intention of shaping up anytime soon?

Can Count Dracula Save Romania's Economy?

The title is more apropos than you would think. When we last talked about Romania, it was in the clutches of an IMF standby agreement as one of the Soviet satellite countries that ran into a bad balance-of-payments situation in June of 2009. The recently Economist featured a downcast article on Romania's economic prospects going forward. In some respects, it's a matter of "political risk" being an unsettled matter in the country:

Nor are foreign investors queuing up to take advantage of Romania’s fertile soil and beautiful scenery or its flexible, cheap and multilingual workforce. Services are particularly underdeveloped. “This could be the back office of Europe,” says a foreign banker, who tries hard to stay optimistic. It could also be a regional hub for companies interested in smaller neighbouring countries. But investors like certainty, not the murky, jerky decision-making that typifies Romanian politics.

Aside from the difficulties attracting foreign investors due to political shenanigans, there's the matter of promoting tourism. For better or worse, Romania is associated with Vlad Basarab Tepes, also known as Vlad the Impaler or "Count Dracula" as immortalized in fiction. In scenic Snagov Lake lies the island of Snagov, whose monastery contains his grave. Despite his global renown (or notoriety depending on your perspective), this site should be of at least as much historical interest as Lenin's Tomb or the Mausoleum of Mao Zedong. Yet, despite the picturesque location, efforts to make it into a tourist destination have been haphazard at best:

A good example of good intentions but poor results comes from Snagov, an island monastery where the real-life Dracula, a prince called Vlad Tepes, is supposedly buried. With much fanfare, the authorities have built a bridge across the lake, a beauty spot, in the hope of attracting tourists. That is welcome: past governments perversely shunned Romania’s most famous son. The new tourism minister, Elena Udrea (a vivacious and wealthy blonde), wants him to take centre stage. She will lead foreign ambassadors on a “Dracula tour” of his castles in the summer. But for humbler visitors, finding the unsignposted way to Snagov is hard. The ill-built bridge is an eyesore. A rough-spoken monk demands a hefty fee and refers to local gypsies (Roma) as “scum”.

It's not quite a Disneyfied attraction just yet. Call it a regrettable metaphor for lack of progress -

Once I had the rarest rose
That ever deigned to bloom
Cruel winter chilled the bud
And stole my flower too soon

IMF's Strauss-Kahn on Progress in Saving Greece

There's an interesting interview of IMF Managing-Director Dominique Strauss-Kahn (DSK) that recently appeared in the Greek newspaper Kathimereni. Protestations that this is a kinder, gentler, less Washington Consensus-style lender aside, the emphasis is still very much on the old triad of liberalization, privatization, and deregulation. Elsewhere, DSK is quite diplomatic and in the process avoids questions about Portugal and Spain, preferring to point out that neither has approached the IMF for help. (He usefully points out as well that the problems facing Greece and Ireland differ significantly.) Moreover, Strauss-Kahn avers that the current episode is not an existential threat to the euro, two-speed economies and everything else. Yet the usually smooth DSK stumbles a bit when asked which industries he sees growth coming from. It kind of beats me, too...

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Q: What specific moves are needed in the next couple of months in order for the fourth installment of the loan to Greece, in March, not to be endangered?

DSK: As the recent assessment of the EC, ECB, and IMF made clear, the program is broadly on track. There has been good progress in a number of key areas--notably in reducing the fiscal deficit and in completing a landmark pension reform. Now, the program is at an important crossroads. The overriding issue--as I reiterated during my visit to Athens--is to get growth going again. Growth--and the jobs that come from it. To achieve this, fundamental structural reforms are needed. For example, opening up services, trade, and the professions; streamlining state enterprises; and improving the climate for business and investment. In short, unlocking the potential of Greek industry and the Greek people. This is not easily done, but if Greece can maintain the momentum of reform, investors will come to realize the country's commitment to change and confidence will grow. I am optimistic Greece can do it.

Q: The IMF has repeatedly noted the need for political consensus. The leader of the main opposition party, who voted against the program, has said he is willing to show solidarity, provided there are changes to the program. Is that something you would accept?

DSK: I met with the leadership of the Opposition during my visit to Athens. I think we agreed that Greece is at a defining moment in its history and that the country can only succeed if there is the broadest possible support for the changes that are needed. That said, it is not up to the European partners or the IMF to make decisions on policy changes--that is the government's prerogative. So ideas for policy changes should, first and foremost, be discussed with the government. What the IMF does is advise on policy options and their feasibility based on our global experience.

Q: Is today's crisis the sole fault of the previous government, or is there enough blame to go around, given that the spreads skyrocketd during the first six months that Papandreou came to power?

DSK: Playing the "blame game" is not helpful. What matters is how to get out of the crisis. To that end, the government is implementing an ambitious program that aims at restructuring broad parts of the economy to make it more competitive, create jobs, and put it on a path of sustainable growth. At the same time, the government is trying to do this in a way that is fair, socially balanced, and protects the most vulnerable groups. So let's look forward instead of backwards--that's what is important now: to support the reform effort and realize the country's true potential.

Q: In that context, did Mr Papandreou take too long to request assistance from the EU/IMF last Spring?

DSK: When the crisis deepened last year, the government took the necessary steps to consult its partners and seek help. Don't forget also that the government had already begun to implement substantial measures to lower the deficit and stabilize the situation--long before the Europeans or the IMF came in. When the pressures increased to unsustainable levels, the government did the right thing and sought assistance.

Q: Is the fact that the IMF and EU will assist Ireland helpful or detrimental to Greece's effort, and how? And should the repayment plans for the two countries be the same?

DSK: Greece and Ireland are very different cases. While Greece was mainly affected by mounting public debt in an uncompetitive and relatively closed economy, Ireland, which has a very open and dynamic economy, faced mainly a crisis in the banking system that became a heavy burden on state finances. These differences mean that the economic programs supported by the European partners and the Fund need to be tailored to those specific circumstances. Regarding the repayment period for Greece, we are--as you know--advocating an extension and we will work with our European partners on a solution to give Greece some further breathing room.

Q: Should Portugal, and even Spain, opt for the EU/IMF mechanism in the near future?

DSK: Neither country has requested help from the IMF, and there is no point to speculate about hypotheticals.

Q: Do you find the idea of issuing Eurobonds helpful, or even necessary at this stage, and can it materialize given Germany's opposition which brings to mind its delay in agreeing with the mechanism for Greece last year?

DSK: The situation in Europe is serious and economic recovery sluggish-- and there is no silver bullet to fix it overnight. What the Eurozone needs is a comprehensive solution. Just as the resolution of the global financial crisis two years ago required a global approach, a European approach is now needed to resolve the problem of low growth in the Eurozone.

Q: What is your view on the potential for the members of the Eurozone going back to their national currencies, or the introduction of a two-speed Europe with a stronger euro for the North, and a weaker one for the South?

DSK: As I said, the situation in Europe is serious, but it is not a threat to the euro. The Eurozone's system and institutions worked well during the "good times" over the past decade. Now they need to be strengthened so as to better deal with crises. I am confident this will happen.

Q: The global crisis demands a globally coordinated response, but how helpful is the fact that Germany is following a tight policy while the Obama Administration has opted for expansionism?

DSK: Again, every country's circumstances are different and the response needs to be customized accordingly. What is important is that national policies do not create or exacerbate global imbalances. That's why we are advocating, within the framework of the G20, the Mutual Assessment Process to help countries monitor and coordinate policy responses that invariably affect their neighbors, regions, and the world. No doubt the world can do better on this point, but we are getting there--one step at a time.

Q: Are you worried that the crisis in Southern Europe could spread to the whole continent and negatively affect growth?

DSK: Clearly, the plight of some European countries affects growth in neighboring countries and across the region. All countries in Europe should be concerned about the slow pace of growth. Looking at the bigger picture, Europe risks faling behind other regions of the world and needs to become more innovative and competitive. Europe has done this before, and it can do it again. A growing and dynamic Europe, of course, is also good for the rest of the world.

Q: At a press conference during the Annual Meetings, I asked you about the difficulty Greece faces in achieving growth in the present world economic environment. Can you please tell us where growth can come from in the case of Greece?

DSK: Well, I pointed to some of the potential areas for growth in my previous answer. Among the sectors that offer strong potential growth are tourism, and the energy and transport sectors, and I am also convinced that liberalization and opening up of closed professions will spur the retail and service sector. The key is for Greece to restore its competitiveness in Europe and beyond. If Greece can implement the reforms in the program, we project growth returning in the latter half of next year or early in 2012. This depends, of course, on there being a positive economic environment in the rest of Europe and in the global economy--because we are all connected now. That is true for Greece as it is for every other country.

Q: How would you describe your personal relationship with PM Papandreou and FM Papaconstantinou?

DSK: Excellent. PM Papandreou and FM Papaconstantinou, as well as other government officials, are showing great resolve in getting the country back on track under very difficult circumstances. Political will and leadership are essential for any economic program to succeed.

Q: How do you assess the lack of coordination among ministers and would the personal involvement of the PM be neded?

DSK: The government is committed and fully engaged. Otherwise an ambitious reform program such as this wouldn't go anywhere.

Q: Finally, may I ask you for your reaction, both on a personal level, as well as head of the IMF, to the demonstrations against you?

DSK: Demonstrations are part of any healthy democracy. It is only natural that some people are unhappy about the changes that need to be made. I understand that. This is a very difficult situation for the Greek people and I do not underestimate the efforts they are making. In fact, I commend them on those efforts--as I believe the rest of the world also is beginning to do. I would only emphasize this point again: when you have to make tough decisions and take difficult measures, it must be done in a socially just manner. From the beginning, we--and the government--have stressed the issue of fairness. Ordinary workers and pensioners have done their part. Now, others in Greek society--including the high-income earners--must do their part too. That is why, for example, strengthening tax administration, and coming down hard on tax evasion, is so important. Yes, this will help increase needed revenues but, more than this, it will help enhance fairness. I believe that,ultimately, people will support reforms--even very difficult reforms--if they feel they are in the best interest of their country and if everyone is contributing their fair share.

Indecent Financial Proposal: IMF Lending to Ireland

No, no, I'm not talking about further dalliances by IMF Managing Director Dominique Strauss Kahn with his underlings which have spawned a bestseller in France on his alleged penchant for indecent proposals. However, I am still talking about Europeans abusing power at the international lender of last resort. (Even with a rather timid redistribution of voting shares away from European countries to fast-growing Asian ones, the impression remains that the Fund is dominated by Western voices--especially since it's still customary that the Europeans get to choose its head and the Americans its first deputy managing director.) A few days ago, I read former IMF Chief Economist Simon Johnson repeat an entirely legitimate criticism of the IMF being asked to help bail out Ireland in an FT article by Alan Beattie:

The Irish case shows how far the fund has drifted from its original purpose. Some officials say it needs to hold a debate about its role. Originally set up to administer the post-war system of fixed exchange rates, the IMF was constructed to tide over countries suffering balance of payments problems while the governments returned to solvency by cutting spending or raising taxes.

With rescues to countries such as Greece and Ireland, inside a monetary union, the emphasis has shifted. “It is strange for the IMF to be lending to a region which has a reserve currency and no balance of payments problem,” Johnson says. One G7 official says: “If the IMF is going to expand its mission to include lending to promote financial stability, we need to revisit exactly what its function is.”

To understand what Johnson means is very simple. Consider the plight of the countries in question. In the IMF Articles of Agreement, the purposes laid out say nothing about assisting countries with essentially fiscal rather than BOP woes alike Greece and Ireland. Rather, lending is supposed to occur when a country has a balance of payments problem. That is, it doesn't have enough foreign exchange to pay for its imports, especially necessities such as food or fuel. A BOP problem can occur in any number of ways, commonly a lack of export receipts that help earn a country much-needed foreign exchange.

Here are the pertinent clauses discussing when the IMF should provide such assistance:

(v) To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.

(vi) In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.

Previously, I discussed my belief and those of several others that the IMF isn't supposed to lend to Greece since its didn't really have problems availing of euros (since it can simply issue debt and exchange it at the ECB for euros under the ECBs emergency arrangements), the currency most of its imports from neighbouring EMU countries are denominated in. True, it is of course arguable that allowing Greece to go would have posed systemic risks to the international monetary system according to the third clause. You can also argue an IMF seal of approval lends confidence to others EU countries that Ireland will eventually find its footing. However, such lending could have been done through arrangements that didn't involve the use of IMF funds. And again, Ireland's particular woes stem largely from guaranteeing its banks' solvency in a manner which ultimately undermined its own solvency--it's a fiscal and not a monetary issue. In any event:

(iii) To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.

In percentage terms, Greece's external deficit remains fairly large, making it arguable to some that Greece does have a BOP problem. However, few would probably argue that this external deficit has been a more important driver of its woes than its fiscal deficit. Turning to Ireland, it shares the same, internationally accepted reserve currency as Greece. Moreover, while Ireland did run a fairly sizeable current account deficit a few years ago, its external imbalance is now quite manageable. In fact, the IMF estimates that it will have a current account deficit of less than 3% this year. Click on the following table for a larger image; it is taken from the October 2010 World Economic Outlook:

Once more, it's an issue of fairness. Developing countries have put in their hard-earned foreign exchange at the IMF. Presumably, they are interested in seeing their contributions used towards alleviating troubles they themselves are likely to encounter like FX shortages as per the IMF's Articles of Agreement. How can you justify using poor countries' contributions meant for addressing BOP problems for rich countries' fiscal woes? It's something IMF brass hasn't really clarified, and this inaction does nothing to reduce the impression that the Fund remains a rich country club. (Think about that before asking LDCs like China to put in more money there.) Why it's...downright indecent.

UPDATE: The IMF's contribution amounts to EUR 22.5 billion

Spain's Too Big to Fail, But is It Too Big to Bail?

Here's something to tide you over while we wait for the details of the impending EU-IMF bailout of Ireland. Dear readers, I point you in the direction of a series of videos the WSJ's Andy Jordan filmed on site in each of the embattled PIIGS countries--Portugal, Ireland, Italy, and Spain. (To rub it in perhaps, he even made a segment on the German paymasters.) Though Italy is thankfully a longer shot at the moment for feeding at the trough, prospects for Spain are troubling indeed. With unemployment hovering at the 20% mark due to a system that handicaps younger workers' ability to find employment (ditto for many other European countries), things aren't looking up on that front. If rethinking the employment and public benefits structure are crucial to Europe's fate going forward, then Spain is certainly in the frontline.

Anyway, the other videos are well worth watching too if you want images to match to the news reports about the plight of peripheral European countries.

Bernanke Happy-Slaps China on Global Imbalances

There's a new Bernanke speech that he will deliver tomorrow at a central banker's shindig in Frankfurt that's sure to garner a lot of comment as it focuses on very topical global economic imbalances. Bernanke is certainly no stranger to coining memorable phrases such as the "global saving glut," and he may have a brand new bag here with his idea of a "two-speed recovery." My summary?

• The US is pursuing appropriately accommodative monetary policies given its situation;
• Emerging economies complain about capital inflows negatively affecting their economies, but it's a natural manifestation of their positive return differentials and higher growth rates;
• Certain developing countries (that's you, China) exacerbate these inflows by intervening to keep their currency weak, making speculative monies enter in the expectation of future revaluation;
• Remedying global economic imbalances will be facilitated by crisis-hit developed economies running accommodative policies and fast-growing developing ones relenting on massaging exchange rates;

Here is the key portion where the above points are made:

It is instructive to contrast this situation with what would happen in an international system in which exchange rates were allowed to fully reflect market fundamentals. In the current context, advanced economies would pursue accommodative monetary policies as needed to foster recovery and to guard against unwanted disinflation. At the same time, emerging market economies would tighten their own monetary policies to the degree needed to prevent overheating and inflation. The resulting increase in emerging market interest rates relative to those in the advanced economies would naturally lead to increased capital flows from advanced to emerging economies and, consequently, to currency appreciation in emerging market economies. This currency appreciation would in turn tend to reduce net exports and current account surpluses in the emerging markets, thus helping cool these rapidly growing economies while adding to demand in the advanced economies. Moreover, currency appreciation would help shift a greater proportion of domestic output toward satisfying domestic needs in emerging markets. The net result would be more balanced and sustainable global economic growth.

Given these advantages of a system of market-determined exchange rates, why have officials in many emerging markets leaned against appreciation of their currencies toward levels more consistent with market fundamentals? The principal answer is that currency undervaluation on the part of some countries has been part of a long-term export-led strategy for growth and development. This strategy, which allows a country's producers to operate at a greater scale and to produce a more diverse set of products than domestic demand alone might sustain, has been viewed as promoting economic growth and, more broadly, as making an important contribution to the development of a number of countries. However, increasingly over time, the strategy of currency undervaluation has demonstrated important drawbacks, both for the world system and for the countries using that strategy.

First, as I have described, currency undervaluation inhibits necessary macroeconomic adjustments and creates challenges for policymakers in both advanced and emerging market economies. Globally, both growth and trade are unbalanced, as reflected in the two-speed recovery and in persistent current account surpluses and deficits. Neither situation is sustainable. Because a strong expansion in the emerging market economies will ultimately depend on a recovery in the more advanced economies, this pattern of two-speed growth might very well be resolved in favor of slow growth for everyone if the recovery in the advanced economies falls short. Likewise, large and persistent imbalances in current accounts represent a growing financial and economic risk.

Second, the current system leads to uneven burdens of adjustment among countries, with those countries that allow substantial flexibility in their exchange rates bearing the greatest burden (for example, in having to make potentially large and rapid adjustments in the scale of export-oriented industries) and those that resist appreciation bearing the least.

Third, countries that maintain undervalued currencies may themselves face important costs at the national level, including a reduced ability to use independent monetary policies to stabilize their economies and the risks associated with excessive or volatile capital inflows. The latter can be managed to some extent with a variety of tools, including various forms of capital controls, but such approaches can be difficult to implement or lead to microeconomic distortions. The high levels of reserves associated with currency undervaluation may also imply significant fiscal costs if the liabilities issued to sterilize reserves bear interest rates that exceed those on the reserve assets themselves. Perhaps most important, the ultimate purpose of economic growth is to deliver higher living standards at home; thus, eventually, the benefits of shifting productive resources to satisfying domestic needs must outweigh the development benefits of continued reliance on export-led growth.

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It's me again. Yes, a lot of it is self-serving: the Fed did not throw down the gauntlet in international currency war by signalling its intention to buy $600B worth of Treasuries, unfettered reserve accumulation by the others introduces worse and inappropriate distortions, etc. At the end of the day, however, I believe that these mechanistic economist's prescriptions have run their course in attempting to solve global economic imbalances. For a more nuanced way, I'll write about that in a later post.

PIGging Out in Portugal, Ireland, and Greece

Let's just say this ain't hog heaven. The Eurozone is again in one of its now-habitual periods of convulsion when peripheral member states display revulsion towards each other and the markets, too. The latest fashion is to blame common EU membership for contagion-like effects evident in the market for these countries' sovereign debt issues. Let's catalogue this tale of ill-advised and very public PIGging out in the appropriate acronymological order. (Merriam & Webster, I just devised the term "acronymological" by the way.)

First, Portugal claims it does not have to return to the capital markets in the immediate future to fund its budget deficit. However, there are noises emanating from it and the others that indicate discontent over Germany showing who's boss around the EU (as if we didn't know already). Portugal's beef [pork?] with Germany revolves around the revocation of the European Financial and Stability Fund's (EFSF) guarantees against giving private creditors a haircut or loss on face value by 2013.

The risk that Portugal will have to turn to the international community for emergency financial assistance is high because of the growing dangers of contagion through financial markets that fear the eurozone debt crisis will spread, the country’s finance minister warned on Monday. “The risk is high because we are not facing only a national or country problem. It is the problems of Greece, Portugal and Ireland. This is not a problem of only this country,” said Fernando Teixeira dos Santos, referring to the possibility that Lisbon will need a financial bail-out...

“This has to do with the eurozone and the stability of the eurozone, and that is why contagion in this framework is more likely. It is not because markets consider we have similar situations. They are only similar in what concerns markets, but as I said they are very different...[m]arkets look at these economies together because we are all in this together in the eurozone, but probably they could look different if we were not in the eurozone. Suppose we were not in the eurozone, the risk of the contagion could be lower...”

The finance minister also stressed that European policymakers needed to improve their communication to markets and investors to prevent undermining sentiment and sparking sharp sell-offs. “Our budget proposals were positively received by the markets, then things were reversed because of the uncertainty around the permanent mechanism for dealing with bail-outs,” he said, referring to the European summit on October 29, when plans for a rescue mechanism to succeed the existing European Financial Stability Facility were outlined in a Franco-German initiative.

“We were like the soccer player running to the goal and ready to kick for the goal, and then someone fouls us...but this time there was no penalty.” He added: “Information is the air that you breathe in the markets. We need that air to be as clean as possible. When it is not clear, the markets get intoxicated.”

The peripheral bond markets fell sharply in the wake of the statement at the [EU] summit because investors feared they would be hit with haircuts, or losses, on their existing bonds. This was in spite of the fact that policymakers had made clear the existing EFSF rescue mechanism, which does not affect bondholders, would remain in place until 2013.

Next, the Irish are more obviously in clear and present danger. The situation in Ireland was compounded by it guaranteeing the viability of its financial institutions without really fully being aware of the ultimate cost of providing such a guarantee. Hence, it's on the hook for, what, a fiscal deficit that's 32% of GDP this year. Ireland has also found attempts to replace EFSF with something more sustainable in the long term difficult as many market participants feared that Ireland would be in a mood to give bondholders haircuts if the EU didn't come to the rescue. We also have to see if the Irish are foolhardy in forswearing EU support in dealing with its woes (for now):

Irish officials insisted on Sunday that they did not need fiscal assistance from the European Union, even as pressure mounted on Dublin to accept aid and present plans to restructure its banking system. Senior European officials held informal deliberations late into the evening to decide whether Ireland needed an aid package before the markets opened, in order to reverse a two-week-old bond market collapse that was briefly halted on Friday. Those discussions broke up, however, without any action taken.

A statement late on Sunday from the Irish department for finance confirmed for the first time that contacts continued “at official level with international colleagues” which was interpreted as a reference to both the European Commission, the European Central Bank and the International Monetary Fund.

However the statement repeated that Ireland was ”fully funded until well into 2011” and it “has made no application for external support.” Although Irish leaders have said the country needs no new cash until June, concerns about its finances have spread to other so-called “peripheral” EU economies, driving up yields on their government bonds.

And last we have Greece. A few months ago, I discussed former Greek Finance Minister Yiannos Papantoniou giving a talk here at the LSE where he was at the receiving end of a tirade from an audience member over his use of currency swaps to temporarily hide the extent of Greek obligations as it tried to enter the Eurozone. In effect, previous Greek administrations have always taken the "everyone else does it, so why can't we?" line of defence. However, we now see that the distortions introduced by the Greeks are of a magnitude greater than a lot of the others. So, officials descended upon Athens to ensure they would no longer be bamboozled by heavily massaged reportage. End result of their investigations? Fiscal adjustments including the recognition of the aforementioned swaps mean this year's fiscal deficit is (surprise!) larger than previously thought:

Greece promised on Monday to stick to its deficit cutting plan while its prime minister said Germany’s tough stance may push debt-laden European nations such as Portugal and Ireland to bankruptcy. George Papandreou, Greek prime minister, said Germany’s insistence on a future mechanism for banks and bond markets to share the pain of any eurozone sovereign debt default from 2013 could break some European Union economies.

“This could break backs. This could force economies towards bankruptcy,” Mr Papandreou said during a visit to Paris. It created a spiral of higher interest rates for countries that seemed to be in a difficult position, such as Ireland or Portugal,” Mr Papandreou said. “This could create a self-fulfilling prophecy.”

On Monday, Eurostat, the EU’s statistical agency said Greece’s 2010 budget deficit and public debt would be significantly higher than forecast, following upward revisions of data for previous years. The budget deficit is projected to reach 9.4 per cent of gross domestic product, missing the government’s current target of 7.8 per of GDP by a wide margin.

In spite of the revisions, announced on Monday, Greece would still achieve “a deficit reduction larger than initially targeted – 6 percentage points of GDP”, the country’s finance ministry said. The public debt is projected to rise from 126.8 per cent to 144 per cent of GDP – the highest in the eurozone as a percentage of GDP.

The increase resulted from the reclassification as general government debt of €18.2bn of accumulated debt owed by public sector corporations and from a €5.3bn adjustment for off-market swaps carried out before such transactions were banned by EU regulations. “The revisions were broadly in line with market expectations ...it’s positive that the after-risks from past fiscal data have been removed,” said Platon Monokroussos, head of financial markets research at EFG Eurobank.

The 2011 budget, due to be announced on Thursday, will be based on the updated data, the finance ministry said. The revisions were the result of a months-long investigation by Eurostat into fiscal data for the years 2006-2009 in co-operation with Elstat, the newly independent Greek statistical agency.

The finance ministry said the outcome marked “a major step to restore transparency in fiscal management and to eliminate controversies over the quality and accuracy of Greek statistics”. The poor quality of Greek statistics reduced the country’s credibility with its EU partners, as previous governments were suspected of massaging data to bring excessive budget deficits closer to the 3 per cent of GDP limit for eurozone member states.

The swap arrangements, criticised because of the high transaction costs involved, were aimed at reducing the cost of financing the public debt. The revisions were flagged as “final” by the finance ministry, but some analysts voiced doubts about projections for the 2010 budget on the grounds that government accounting systems still lag eurozone standards.

International auditors hired by the finance ministry this year are still working on current data from state hospitals, social security funds and local government authorities. “The revised data are a step in the right direction but until the quality of accounting improves, Greek statistics will be open to question,” said Stefanos Manos, a former finance minister and president of Drasi, a think-tank

Some points from me before I end:

• Portugal is mouthing off but its woes are comparatively less dire than the other two's;
• Unlike Krugman, I do not think premature austerity is to blame for Ireland's woes. After all, what's so "austere" about running a fiscal deficit that's 32% of GDP to bail out troubled lenders? The trouble, instead, is its overcommitment to bailing out its ailing financial sector come hell or high water without understanding the true cost of that commitment;
• These accounting purges being undertaken in Greece to bring it up to modern national accounting standards have made it look worse in the short run by adding to its reported deficit, but it will benefit it in the long run by clearing up systems of monitoring and reporting as well as making it less tempting to do some Enron-inspired bookkeeping.

Anti-Diplomacy: PRC, Germany Pre-G-20 Salvos

There's something to be said for the idea that criticizing Chinese leadership excessively concerning its economic policies may cause it not to do what it would otherwise have done on its own--eventually. Another idea worth airing is that the Communist Party leadership is not monolithic. Put these two things together and you get a previous story I featured that suggests the PBoC was already moving in this direction of setting targets for its external balance. But, see how things change when more belligerent voices in the Chinese leadership hear Americans berating them to do the same. Nobody wants to be thought of as giving in to the Yanks, as the article mentioned. China has to do it of its own volition. Otherwise you get this sort of thing:

China said on Thursday that the U.S. Federal Reserve's move to ease monetary policy risked undermining the global economic recovery, adding that Washington "should not force others to take medicine for its own disease". A senior Chinese central bank official told reporters at the G20 summit in Seoul that the Fed's move had caused "strong concern" around the globe, and major reserve countries ought to factor in the global impact of their policies...

Zhang Tao, director of the international department of People's Bank of China, also warned that disorderly capital inflows resulting from the Fed's action could hurt emerging markets. "For emerging countries, capital inflows may lead to significant increase in asset prices and foreign exchange reserves, and many countries are concerned about that," he said. "Doubtlessly, disordered international capital inflows will make emerging countries very vunerable. As emerging countries are important for the global economic recovery, that will greatly increase the downward risks in the world economy."

Referring to an idea floated by Washington for numerical targets to be set for trade imbalances among G20 countries, a Chinese Foreign Ministry also told reporters that it was "not realistic" to have a current account target that fits all. A Foreign Ministry spokesman added that Chinese President Hu Jintao, discussing Washington's wish to see a sharp revaluation of the yuan, had told U.S. President Barack Obama earlier that reform of the currency would have to be gradual.

And now for Germany. Let's just say that this transatlantic relationship is on the ropes as German officialdom no longer feels the need to be diplomatic. Honestly, I do not think Germany's demographic or cultural characteristics are conducive to it going on a debt-fuelled shopping spree in classic American style:

Germany's undiplomatic outbursts against U.S. policy, calling it "clueless" before a G20 summit, show growing estrangement on economics as America's focus shifts away from transatlantic ties to domestic challenges and Asia. "The Atlantic is getting wider," said Anton Boerner, head of Germany's Foreign Trade Association, who spoke of a "creeping alienation" between America and Europe, which has been exacerbated by the global financial crisis.

Germany and the United States often criticize each other's approaches to aiding economic recovery, with U.S. calls for more expansive policy falling on deaf ears in fiscally disciplined Germany. But Berlin has taken the rhetoric to a new level. Finance Minister Wolfgang Schaeuble, 68, said last week that the U.S. Federal Reserve decision to buy $600 billion of government bonds undermined U.S. credibility and was "clueless." There was no point, he said, in pumping money into the markets.

China and Brazil were among those echoing his comments but U.S. officials were particularly stung by Schaeuble and German Economy Minister Rainer Bruederle saying the Fed move amounted to "indirect manipulation" of the dollar to boost exports; this at a time when Washington is criticizing China for exactly the same kind of strategy. "It's not acceptable for the Americans to criticize China for currency manipulation then slyly help the dollar by printing at the Federal Reserve," Schaeuble told Der Spiegel magazine.

Coming ahead of a G20 summit in Seoul where nerves about trade and currency imbalances will top the agenda, the comments were strong even compared to the frank tone that U.S. Treasury Secretary Timothy Geithner uses with the Germans and others. "The harsh tones betray major nervousness among top decision makers," said Boerner. "The effects of the financial crisis have made them insecure and afraid..."

But Chancellor Angela Merkel and her minister "think pretty much alike" even if her language is more moderate, said a German government source. She refrained from using names, for example, when she criticized policy keeping currencies artificially low to boost exports as short-sighted.

Simon Green, a history professor at Aston University in Britain, said the Americans' quantitative easing was a "red flag" to the Germans with their historic fear of inflation. Germany has made a painful effort to get competitive in the past decade of slow growth and stagnant wages and is unhappy to see "the Americans saying 'let's throw on the press, print money and get competitive that way,'" said Green.

One regional German paper, the Hannoversche Allgemeine, came to the conclusion that "never before has the Merkel government had such a direct confrontation with the United States..." But the chancellor and Bush's successor Barack Obama have always had a difficult time communicating, said William Drozdiak of the American Council on Germany...Merkel has doggedly refused U.S. overtures to fire up domestic economic demand in Germany.

Welcome to G-20.

World Bank President Bob Zoellick, Gold Fetishist?

What about Bob, indeed. Over the past day or so, the blogosphere and global markets have been alight over World Bank President Robert Zoellick alluding to gold serving as a reference point for international reserve holdings. Do a quick search of "Zoellick gold standard" and see for yourselves. Meanwhile, the rising price of spot gold--now past the $1,400 level--is being attributed to Zoellick's statement triggering a renewed gold rush. Before going any further, some context is necessary. On Sunday, Zoellick penned an op-ed in the Financial Times on how the G-20 must look beyond Bretton Woods II. Note that in Zoellick's usage, BWII isn't really referring to the now-infamous Dooley, Folkerts-Landau and Gerber concept. Instead, he is referring to the post-1971 international monetary system where the dollar-gold standard was superseded by the current system free of such restraints. For the sake of reference, here's what he said in its entirety in the last of his suggestions:

Fifth, the G20 should complement this growth recovery programme with a plan to build a co-operative monetary system that reflects emerging economic conditions. This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi that moves towards internationalisation and then an open capital account.

The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today.

Is Zoellick really advocating the return to an international monetary system that involves referencing currencies to gold--a seeming return to a pre-Nixon era? While gold bugs may see this statement as another sign to buy yet more gold, I have my own share of doubts. While it certainly looks striking that the "World Bank president" would advocate something rather drastic, remember that Zoellick is a leftover appointee from the Bush administration who has served in many national posts including US trade representative under Dubya. When it was still very much a force to be reckoned with Zoellick was also aligned with the neoconservative Project for the New American Century. So, let's just say that despite being American, what he says doesn't necessarily jibe with views of the Obama administration.

The backlash against Zoellick is expectedly strong. Call it the revenge of the textbook toters. Among other arguments raised are that gold is too volatile to serve as a reference, that anchoring monetary policy to gold ignores the deflationary effects which set in during the Great Depression, and that the physical stock of gold cannot increase at a rate meeting growth in global trade. Then again, others are not so dismissive and call for a debate on the reintroduction of a gold standard in some form.

Me? I am honestly puzzled by Zoellick's motives in bringing up this matter. First, he's at the nominal development institution of the Bretton Woods twins (the World Bank) not the monetary institution that has more input on such matters (the IMF). Second, nobody's particularly keen on the idea, so it's a moot point. Perhaps the neocon in him is emerging to try and make the Obama administration look bad given his relatively esteemed international post. Hey, if Sarah Palin can play Whack-O-Bama, why not Bob? The WSJ noticed this odd monetary couple, too.

At any rate, Reuters offers some thoughts on the prospect of world markets warming up to a new gold standard:
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HOW MIGHT A NEW GOLD STANDARD WORK?

Zoellick's comments were vague, but analysts say he may be pushing for a system in which the World Bank's own currency--Special Drawing Rights or SDRs [that it also uses but the IMF issues, actually]--is changed to reflect the value of the dollar, euro, pound, yen and the yuan and somehow incorporate gold.

The suggestion does not set out, for example, how such a standard might work when monetary authorities need to make extraordinary provisions such as quantitative easing or sterilised currency intervention. It also does not make clear how it would prevent monetary authorities from trading around or outside of any bands that might be set.

IS IT A REALISTIC PROPOSAL?

The initial response, given the size of the gold market alone, is no. Gold is a precious metal by virtue of its limited supply, and annual gold supply could not keep pace with any increase in money supply, especially if central banks make use of quantitative easing to flush their economies with cash.

"Unlike the World Bank, we do not believe that a form of the gold standard will return. Very simply, there is not enough gold supply in the world for the metal to perform in this role," says UBS precious metals strategist Edel Tully. "As Paul Donavon, from UBS Global Economics points out, any reserve currency needs a supply that can grow as rapidly as global trade. Gold supply falls significantly short of this basic requirement."

WOULD THERE BE INTERNATIONAL SUPPORT FOR IT?

Zoellick's suggestion that gold be used as an international reference point of market expectations for price pressures and future currency values comes in the middle of a virtual international currency war. The U.S. dollar has fallen broadly this year, having lost nearly 13 percent against a basket of major currencies in the past five months. That has triggered an outcry from many key emerging economies, which have seen the competitiveness of their exports dwindle as well as a pick-up in so-called "hot money" inflows from speculative investors.

The United States continues to exert pressure on China to allow its yuan currency to appreciate and wipe out some of the competitive edge of the world's biggest exporter, and members of the G20 have rejected placing limits on currency and trade surpluses as a means of rebalancing the global economy.

With a distinct lack of accord over how to correct the surpluses of the emerging world and the deficits of the developed one, the chances of a deal on adopting a gold standard, in any form, appear limited. "It is conceivable for greater cooperation in the currency region, but gold may not necessarily be at the heart of any realignment of the currency system," says Daragh Maher, deputy head of global foreign exchange research at Credit Agricole CIB. "More cooperation, such as a (U.S. Treasury Secretary Timothy) Geithner-like approach, but not specific target levels (for current account imbalances) but something that would involve not tolerating imbalances domestically may be something to be considered," he says. With the Federal Reserve set to pump over half a trillion dollars into the U.S. economy, the rise in money supply and subsequent rise in inflation would make it difficult to hold enough gold.

Hans Redeker, global head of foreign exchange strategy at BNP Paribas, says the supply of money would depend on the amount of gold one holds. So an increase in money supply would have nothing to do with economic circumstances. "It's a step in the right direction, but it is not going to fly. People are desperately seeking ways to stem the wave of liquidity (from U.S. monetary easing), but bringing back the gold standard is not realistic," he says. Redeker adds that throwing gold into the global currency mix would not help stem excess liquidity by the United States, which is fuelling inflation especially in China and emerging Asia.
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If Zoellick's objective was making Obama look bad in pointing out the increasing folly of using the dollar as a global reserve currency given its issuer's nonchalance at debasing it, then consider Bob's job done. That is, even if the suggestion has few real policy implications with regard to incorporating gold in a basket of currencies. ImPalin' [sic?] US monetary policy sure is fun when your erstwhile political opponents are at the controls. The SGDR--who'd have thunk it?