Brookings: Topics - The Euro Crisis

Germany: A Global Miracle and a European Challenge

Carlo Bastasin — Thu, 09 May 2013 14:00:00 -0400

INTRODUCTION

In 1994, five years after the fall of the Berlin Wall, the Germans feared that the unification of the two Germanys had failed. In 1997 the term "Reformstau" (the reform deadlock) had been elected as the "word of the year". In 1999 and 2000 the weekly magazine The Economist called Germany "the sick man of Europe". In 2003 the German economy was back in recession.

Until 2004, Germany was struggling in a spiral of a seemingly unstoppable decline, without precedent for its length. Since 2004, Germany has emerged from its economic sluggishness with a performance that, considering the preceding fifteen years, appears to be exceptional. Today, people commonly interpret the rebirth of the German economy as a new Wirtschaftswunder, an economic miracle comparable to that of the postwar period and able to provide such a political prestige and diplomatic assertiveness to determine the fate of the political and institutional framework of the rest of Europe.

Over the past seven years, other European countries have had comparable growth rates, Sweden and Switzerland in particular. France has been growing at higher rates if one takes into account a longer period, but probably as a result of the fiscal stimulus induced by a structural budget deficit which regularly exceeded the average of other euro area countries. But the German exception lies in having permanently transformed its economic model in line with the global challenge, showing that the opening of national economic systems can be an opportunity for prosperity. The transformation occurred by introducing more market elements in the economy. This has allowed the achievement of the traditional shared goals of German society - starting with full employment - which have always characterized the Sozialmarktwirtschaft, the social market economy.

Income divergence has increased. The labor market has become dual. Seven million workers, many of them foreigners or migrants, have become dependent on extremely low salaries.

However this has been possible only at the cost of giving up the traditional goal of egalitarianism, both within the German society and in the economic relations with the European partners. Income divergence has increased. The labor market has become dual. Seven million workers, many of them foreigners or migrants, have become dependent on extremely low salaries. Balance of payments disequilibria, and their re-distributional effects within the euro area have been regarded as irrelevant.

In order to defend at least some parts of the social market model, German governments since the early 1990s have accompanied the economy’s internationalization process initiated by companies and major financial institutions. The common political analysis behind this is that a population of 1.15 percent of the world, which currently produces more than 5 percent of global GDP4, can maintain its standard of living only by tying its growth to that of countries bringing 6 billion people out of relative poverty.

For this reason, the entire German production system had to and was able to strengthen its export orientation, while facing the major geopolitical changes that have directly involved the country: the German reunification, the European monetary unification, Eastern Europe opening to international trade and, finally, the entrance into the markets of large areas of the world up to the full development phase of globalization.

The German experience has been proposed by Chancellor Angela Merkel as a reference model for the entire euro area: "To be competitive in the world is not a requirement for Germany, but for the entire euro area, a group of countries which accounts for 7 percent of the world population but produces more than 20 percent of global GDP". Inevitably, it becomes important to understand whether the features of the German economic miracle are identifiable and replicable as a historical process of reform. The indications of this analysis are that the process of transformation of the German economy was born long before becoming a political project, under the impulse of a group of industrial and financial actors subject to the pressure of global competition. Only later, an intensive set of government-led economic reform programs accompanied the transformation of production, allowing the entire economy to benefit from their acquired competitive success. Therefore, the possibility of replicating the German success must lie not only in the process of political reform, but in a double and parallel evolution of the production structure and regulatory framework consistent with a long-term project. More importantly, Germany has deliberately forged its fiscal and labor policies as to ensure a very high net savings surplus. This strategy has drained resources from the rest of the euro area in two ways: The first via lower imports and the second through a huge amount of capital incomes flowing back from the countries of the euro area that had received huge German financial investments. I estimate this effect at a yearly 0.75 percent of German GDP and at an equivalent yearly amount subtracted from the euro area periphery for ten years. Given the incapability of the countries receiving the flows of capitals to put them to good use, the German strategy has aggravated the imbalances within Europe and — among other causes — seems to have contributed dramatically to the origins of the euro crisis.

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Carlo Bastasin

Image Source: © Tobias Schwarz / Reuters

Geopolitics in the Eastern Mediterranean: A Cypriot Perspective

Thu, 09 May 2013 14:30:00 -0400

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May 9, 2013
2:30 PM - 4:00 PM EDT

Saul/Zilkha Rooms
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

In recent months, the Republic of Cyprus has been at the center of a number of critical geopolitical developments—holding a largely successful presidency of the European Union (EU), announcing the discovery of large offshore natural gas deposits, and undergoing an economic crisis that led to a bank bailout and raised new uncertainties about the future of the eurozone. The Cypriot government has also announced recently that talks with Turkey could be re-launched in the fall in a new attempt to resolve the political standoff that has divided the country for a generation.

On May 9, the Center on the United States and Europe at Brookings (CUSE) and the Energy Security Initiative (ESI) hosted the Minister of Foreign Affairs of Cyprus Ioannis Kasoulides for a public address. In his remarks, the foreign minister offered his perspectives on a range of issues that are shaping Cyprus’s role in Europe and across the rapidly evolving Eastern Mediterranean region.

Minister Kasoulides previously served as the Cypriot government spokesman from 1993 to 1997. He was first appointed minister of foreign affairs in 1997 and served in that capacity until 2003. During his initial term as foreign minister he led the diplomatic effort that marked the initiation and completion of Cypriot accession negotiations to the EU. From 2004 to 2013 Kasoulides was a member of the European Parliament, where he served as the vice president of the EPP group and head of its foreign affairs working group. He was appointed to a second term as foreign minister in 2013.

Vice President Martin Indyk, director of Foreign Policy at Brookings, offered introductory remarks.

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The Social Impact of the Eurozone Crisis in Southern Europe: The EU Response and the Challenges Ahead

Fri, 03 May 2013 10:30:00 -0400

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May 3, 2013
10:30 AM - 12:00 PM EDT

Saul/Zilkha Rooms
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

As the ongoing eurozone crisis continues to threaten the European single market and endanger the global economy, it has unleashed uncertainties about Europe’s political and institutional durability. The economic crisis has also become increasingly a social crisis, especially in the heavily-indebted states of Southern Europe, where austerity measures and high unemployment have led to questions about the sustainability of the current situation.

On May 3, the Center on the United States and Europe at Brookings (CUSE) and the European Parliament’s Liaison Office, hosted a discussion with European Parliament Vice-President Gianni Pittella. In his remarks, Mr. Pittella discussed the social impact of the crisis and how the European Parliament has responded to address these challenges.

Gianni Pittella has been the first vice-president of the European Parliament since July 2009 when he was re-elected for the third time with the Democratic Party from the Southern Italy electoral district. He was first elected as a member of the European Parliament in 1999. Mr. Pittella is the author of numerous books, including most recently, Federalismo Avvelenato (Fondazione Zefiro, 2011) and A Brief History of the Future of the United States of Europe (Fazi, 2013), which he coauthored with Elido Fazi.

Brookings Nonresident Fellow Clara Marina O’Donnell provided introductory remarks and moderated the discussion.

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The Way Forward for the Eurozone and Europe: A Conversation with European Policymakers

Thu, 18 Apr 2013 16:15:00 -0400

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April 18, 2013
4:15 PM - 6:00 PM EDT

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

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On April 18, Global Economy and Development at Brookings and the Center for the United States and Europe hosted a discussion on the European economy and the ongoing crisis in the eurozone with a distinguished panel of European policymakers. Panelists included: Olli Rehn, European Commission vice president for economic and monetary affairs and the euro; Jeroen Dijsselbloem, Dutch finance minister and president of the Eurogroup; Klaus Regling, managing director of the European Stability Mechanism; Werner Hoyer, president of the European Investment Bank; and Jorg Asmussen, executive board member of the European Central Bank. Brookings President Strobe Talbott provided introductory remarks. Vice President Kemal Derviş, director of Global Economy and Development, moderated the discussion.

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Europe on a Slippery Slope

Thomas Wright — Wed, 17 Apr 2013 00:00:00 -0400

Editor's note: This article originally appeared in the International Herald Tribune.

Throughout the euro crisis, observers have been asking if the euro zone will disintegrate — as if it is a decision that will be made by its leaders at some point in the future. This holds out the prospect of a great historic choice: Europeans can choose to properly unite and overcome their crisis or they can choose dissolution. We wait with bated breath for the next summit or the latest “most crucial month in the euro’s history,” which now seems to come several times a year.

But, this may be the wrong way of looking at the euro crisis. Integration and disintegration are not just the products of deliberate decisions. They are both processes, set in motion by actions regardless of the stated intentions of leaders. Once underway, each process takes several election cycles — probably a decade or so — to reach completion. Only one will prevail in the end, but it is possible that in the early stages these two processes can coexist even as each vies for supremacy.

Looked at this way, the euro zone is in serious trouble. The events of the past six months are consistent with a process of disintegration, while the process of integration has steadily weakened. The question is no longer, “Will Europe unravel?” We should be asking, “Can European disintegration be reversed?”

The trigger that brought integration to a halt and set disintegration in motion is surprising. In July 2012, the European Central Bank chief, Mario Draghi, declared that he would do whatever it takes to save the euro, and in August he kept his promise by introducing a program of Outright Monetary Transactions to finance troubled member states, thus bringing down the price of sovereign debt. The temporary lull led José Manuel Barroso, president of the European Commission, to confidently declare that “the existential threat against the euro has essentially been overcome.”

But Barroso could not have been more mistaken. The E.C.B.’s actions, while welcome, had a major unintended consequence. European governments became complacent and stopped pushing the policies needed to save the euro. The German government now believes that a quantum leap toward deeper fiscal and political integration through treaty change (the only way it could be done) is no longer necessary. At the December summit meeting, it was taken off the table. Instead, the Germans will push for incremental steps to increase coordination. Banking union has been watered down to the point where it is grossly insufficient. The euro zone is proposing a common supervisory mechanism, but banking debt will remain primarily a national concern.

The optimists say that the small steps the euro zone has taken are the first in a long journey, but this assumes that it will be easier to accomplish extraordinarily difficult goals later. Unfortunately, European politics are becoming polarized in a way that makes further progress unlikely. The core member states have run out of patience with the periphery and do not want to take on new commitments, such as a real banking union. Voters in the periphery are turning toward politicians who will say no to German austerity, as Italians recently demonstrated.

As integration stalled, the euro zone experienced its first major act of disintegration. The spectacularly botched rescue of Cyprus formally created a two-tier euro zone. Deposits are safer in Germany than in the periphery and this has enormous implications. We should expect large-scale capital flight if markets fear that other states will need a bailout. With capital controls in place, Cyprus itself is half in and half out of the single currency.

The next decisive moment may be when a member state on the periphery elects a government with a cast iron mandate to say no to a German government that has a cast iron mandate not to buckle. This almost happened in Greece in June of 2012, and it may yet happen in Italy in a couple of months. This could cause a withdrawal of E.C.B. support and an escalation that will lead to new acts of disintegration.

Winston Churchill once said: “It is not enough that we do our best; sometimes we have to do what’s required.” All European leaders should have this advice engraved onto a plaque and then affix it to their desks. Throughout the euro crisis, they have sought credit for good intentions and effort. They continually point out that the euro zone has moved far further and faster than anyone could have imagined before the crisis.

They are right, but it is completely irrelevant.

There are other forces at work and at the moment they are prevailing. Europe’s leaders need to be honest about the steps necessary to reverse a long spiral of disintegration. If they can’t do that, they need to ask how they can manage the process in the least damaging way possible.

Authors

Thomas Wright

Publication: International Herald Tribune

Image Source: © Kai Pfaffenbach / Reuters

Economic Policy’s Narrative Imperative

Kemal Derviş — Mon, 15 Apr 2013 10:40:00 -0400

The best advice I received when taking up policymaking responsibilities in Turkey more than a decade ago was to take “a lot of time and care to develop and communicate the ‘narrative’ to support the policy program that you want to succeed.” The more that economic policy is subject to public debate – that is, the more democracy there is – the more important such policy narratives are.

The crisis faced by the European Union and the eurozone is a telling example of the need for a narrative that explains public policy and generates political support for it. A successful narrative can be neither too complicated nor simplistic. It must capture the imagination, address the public’s anxieties, and generate realistic hope. Voters often sense cheap populism.

European Central Bank President Mario Draghi provided such a narrative to the financial markets last July. He said that the ECB would do everything necessary to prevent the disintegration of the euro, adding simply: “Believe me, it will be enough.”

With that sentence, Draghi eliminated the perceived re-denomination tail risk that was highest in the case of Greece, but that was driving up borrowing costs in Spain, Italy, and Portugal as well. It was not a populist message, because the ECB does indeed have the firepower to buy enough sovereign bonds on the secondary market to put a ceiling on interest rates, at least for many months.

Central bankers, more generally, are typically able to provide short- or medium-term narratives to financial markets.

Central bankers, more generally, are typically able to provide short- or medium-term narratives to financial markets. US Federal Reserve Board Chairman Ben Bernanke provided his own by pledging that US short-term interest rates would remain very low, and the Bank of Japan’s new chairman, Haruhiko Kuroda, has just provided another by saying that he will double the money supply so that inflation reaches 2%.

While central bankers can provide such narratives to financial markets, it is political leaders who must provide the overall socioeconomic messages that encourage long-term real investment, electoral support for reform, and hope for the future. Central bank alchemy, to borrow a term from the US journalist Neil Irwin’s new book, has its limits.

Europe, in particular, needs a narrative of long-term hope that will trigger a real recovery. France is coming closer to the danger zone, and even Germany’s annual GDP growth is falling well below 1% per year. In the meantime, the easing of sovereign interest-rate spreads provides little comfort to the growing army of unemployed in southern Europe, where youth unemployment has reached dramatic heights – close to 60% in Greece and Spain, and almost 40% in Italy.

The narrative should address three essential questions. How can the European model of strong social solidarity and security be reformed, but endure? How can economic growth be revived and sustained throughout the EU? And how can Europe’s institutions function with enhanced legitimacy to accommodate countries that share the euro and others that retain their national currencies?

For starters, a revolution is required in the organization of work, learning, and leisure. Social solidarity, essential to European identity, can and must include longer work lives, but also more work-sharing, adult learning, and shorter average work weeks (particularly close to retirement).

Such flexibility requires the consent of all: employees must adjust to changing requirements; employers must re-organize their enterprises to allow more work-sharing, work from home, and learning intervals; and governments must overhaul taxes, income support, and regulation to promote a “flex-solidarity revolution” that encourages personal choice and responsibility, while remaining committed to social cohesion. This can lead to a better future for all, with citizens gaining better access to adult education, having more free time to pursue personal interests, and remaining productive and occupationally engaged far longer into their healthy lives.

Europe does not need Asia’s rates of economic growth. It can secure decent jobs and prosperity, with a sustained annual growth rate of around 2%.

Europe does not need Asia’s rates of economic growth. It can secure decent jobs and prosperity, with a sustained annual growth rate of around 2%. To achieve that, German voters should be told not that their country’s resources will forever flow to Spain, but that their wages can rise at twice the rate of the recent past without risking inflation or a current-account deficit, because Germany has the world’s largest external surplus.

Service-sector industries throughout the EU must be opened up. The countries with stronger fiscal positions should take the lead in a major pan-European skill-upgrading program. The number of pan-European scholarships should be doubled. School programs everywhere should aim to educate trilingual citizens.

Moreover, a full European banking union with shared resources for resolution should be created without further delay. The European Investment Bank, which received a significant capital increase in 2012, should add a large investment-support program for medium-size enterprises to its current operations, with a subsidy financed from the European budget to encourage first-time job takers for a limited period. Jobs and training for young people must be the centerpiece for the new growth pact, and projects must move ahead in “crisis mode,” rather than according to business as usual.

Finally, while monetary union obviously requires greater sharing of sovereignty, there should also be a “greater Europe” that includes the United Kingdom and others. This implies two-tier institutions that can accommodate both types of countries: the “euro-ins” and those that prefer to preserve their monetary sovereignty in a larger Europe built around a vibrant single market and common democratic values.

These interconnected visions can and must be realized if Europe is to thrive again. Together, they form a compelling narrative that European leaders must begin to articulate.

Authors

Kemal Derviş

Publication: Project Syndicate

Global Economic Recovery Stuck Below Takeoff Speed

Eswar Prasad and Karim Foda — Sun, 14 Apr 2013 12:17:00 -0400

Editor’s note: This commentary is based on research and analysis from the April 2013 update of Tracking Indexes for the Global Economic Recovery (TIGER) interactive map, which appears on the Financial Times Web site.

The global economic recovery remains stuck below takeoff speed, unable to achieve liftoff and facing the risk of stalling. Half-hearted fiscal austerity measures are proving to be a drag on growth and doing little to rebuild investor and consumer confidence.

Monetary policy continues to shoulder the burden of limiting downside risks and has kept financial markets buoyant even in the face of weak growth prospects.

The Brookings-FT Tiger index shows that growth momentum remains weak in nearly all major advanced and emerging market economies. The best that can be said about the weak pace of economic activity is that it has bottomed out in some key economies. However, prospects of a strong cyclical pickup in growth are likely to be hampered by continued policy uncertainty and concerns about further financial market turbulence, with the simmering euro zone debt crisis once again coming close to boiling over.

The US economy continues to be a relatively bright spot, with economic activity showing modest strength and equity markets booming. Consumer demand continues to prop up the weak recovery, although even that is tenuous as labor market performance remains weak. The Fed’s commitment to maintain easy monetary policy until the unemployment rate falls to 6.5 percent has boosted bond and equity markets. The Fed’s actions have also helped to limit downside risks to growth in the short term but at the cost of creating greater financial system risks. Fiscal policy, both directly and through the uncertainty about its future course, is hampering the recovery.

Growth in the core eurozone economies, including Germany and France, remains weak while the eurozone periphery remains mired in a danger zone.

Growth in the core eurozone economies, including Germany and France, remains weak while the eurozone periphery remains mired in a danger zone. The backstop provided by the ECB’s interventions bought some time for European policymakers, who have been squandering it with political squabbling. There has in fact been some progress on fiscal and structural reforms in countries such as Greece and Spain. However, in general the pace of reforms in the eurozone periphery economies has been far too slow. There are few grounds to anticipate improved growth momentum in these economies, which continue to post shrinking GDP levels. They also have dismal levels of business and consumer confidence, as well as financial systems that are still in distress and unable to provide much credit to finance a recovery. Moreover, recent developments such as the outcome of the Italian elections and the mishandled Cyprus bank rescue plan have raised the risks of an unpleasant end-game to the crisis.

The Bank of Japan’s new leadership has clearly signaled its intention to employ a broad and aggressive set of unconventional monetary policy measures to reverse deflation and support growth. For these measures to gain traction, they need to be supplemented by structural reform measures that are essential to revive the economy’s productivity and competitiveness. Bolstering Japan's productivity and long-term growth prospects requires reforms of the tax system, labor markets, and various aspects of the regulatory regime.

Emerging markets are treading water as their policy space becomes increasingly constrained and they continue to be buffeted by a weak external environment.

Emerging markets are treading water as their policy space becomes increasingly constrained and they continue to be buffeted by a weak external environment.

The outlook for China’s economy is evenly balanced, with some indicators such as industrial production suggesting that growth has stabilized. Inflation appears to have moderated, leaving room for policy stimulus if growth were to slow. The new leadership has hit the ground running in terms of laying out its economic reform agenda and making a series of statements and high-level appointments that bode well for reform prospects. The difficult task of developing specific action plans and implementing them lies ahead. Still, it seems clear that the government is prepared to accept lower growth than in the past decade so long as that growth is more sustainable and increasingly driven by private consumption and productive investment.

In India, the optimism engendered by a wave of modest but important reforms at the end of 2012 has given way to renewed gloom as the February 2013 budget did not sustain the reform momentum. The budget contained some steps to put public finances on a more sustainable path, but even the modest deficit reduction goals may be upended by weak growth. The large current account deficit remains a source of vulnerability and the high level of inflation has constrained monetary policy’s ability to support growth.

Latin American economies have hit a rough patch, with countries like Argentina and Brazil experiencing significant slowdowns. Even Mexico, one of the strongest performers in the region of late, is in danger of losing momentum as export growth has been hit hard by weak external demand.

Politicians around the world continue to avoid tough structural reforms, instead relying on central banks to continue propping up growth. Policy and political uncertainty remain sources of drag that could prevent the world economy from attaining liftoff, raising the risk of a crash.

Authors

Eswar Prasad
Karim Foda

Image Source: © Bobby Yip / Reuters

A World in Turmoil: An Exploration of Issues Affecting Today's Global Order

Martin S. Indyk and Javier Solana — Fri, 05 Apr 2013 00:00:00 -0400

With a range of critical issues confronting the U.S. and the international community today, Distinguished Fellow Javier Solana and Vice President for Foreign Policy Martin Indyk discuss some of the most pressing challenges, from the war in Syria to the Euro crisis to Iran’s nuclear program.

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A World in Turmoil: An Exploration of Issues Affecting Today's Global Order

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A World in Turmoil: My Conversation with Javier Solana

Fri, 05 Apr 2013 00:00:00 -0400

There are many tensions and problems facing the world today. Distinguished Fellow Javier Solana and I discussed some of the most challenging issues in the current geopolitical landscape, including the Euro crisis, the war in Syria, and Iran's brinksmanship.

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Cyprus as Another Euro-Solution

Jacques Mistral — Wed, 27 Mar 2013 12:00:00 -0400

After 10 hectic days, Cypriots will return to economic life. The price, however, is an inevitable and costly adjustment plan. But contrary to many predictions, the eurozone and the Cypriot government have been able to find a solution in less than 10 days. Moreover, the eurozone has avoided yet another financial hurdle that, despite its small size, was described as having the potential to start another acute phase of the euro crisis.

The management of the eurozone crisis over the last three years has proven to be extremely tortuous. It remains so, and this episode will certainly not be the last. However, observers might also point to how the management by congressional leaders of the U.S. fiscal and deficit problems reveals similar political complexities. Could both be the inevitable result of a democratic, diverse, continental political constituency?

What people need to understand about the eurozone is its continuous willingness to ensure the future of the euro, and its (until now) proven capacity to find compromises despite diverging national interests.

Cyprus has been recognized for months as a ticking bomb within the eurozone, mixing a hypertrophied banking system (that produced jobs and wealth for Cypriots) with huge Russian deposits and suspected money laundering.

Cyprus has been recognized for months as a ticking bomb within the eurozone, mixing a hypertrophied banking system (that produced jobs and wealth for Cypriots) with huge Russian deposits and suspected money laundering. It seems that this had become Cyprus’s most important comparative advantage. The fight against money laundering is supposed to be a great cause of the OECD countries, and it is surprising to note that this aspect did not receive appropriate weight when commenting on the unconventional tools used by the troika to design its plan. The Cypriot banking system is not like the average banking system of Southern Europe. It is a case in itself and deserves a solution of its own.

The “success story” of Cyprus was destroyed by the haircut on Greek bonds; Cypriot banks hold massive amounts of Greek bonds on behalf of their foreign clients. Incidentally, this says a lot about the prowess of this supposed “international financial center” and the awareness of its clients. For many reasons, mostly the country’s democratic process, the active search for a solution to problems in Cyprus had been postponed for months until Saturday, March 16, when an agreement was reached between the newly-elected president of Cyprus, the eurozone governments, and the troika. On that date, every old prejudice about the mismanagement of the eurozone crisis, that had been shelved for the last year, suddenly resurfaced with a new torrent: of criticisms (an ill-conceived plan); of denunciations (a crisis of stupidity); of rejection (Europe is for people, not for Germany); of financial horrors (inevitable propagation of the Cypriot bank run); and finally of doomed forecasts (be alert, the breakup is coming).

Yet one week later, it is interesting to visit the control room and watch the radar screens:

The agreement? Better designed and operational as of Monday, March 25;
Bank runs propagation? No sign (even in the London branches of the two Cypriot banks);
European periphery bond market? A definitely strong first quarter;
Stock markets? Stable;
Exchange markets? Stable.

However, we should not consider this summary to mean that this new episode in the eurozone saga has been more efficiently managed than the previous ones. Definitely not!

Two examples among many explain why this is not the case. First, the idea to tax every bank account whatever its amount was not a product of “German stupidity” but reflects a demand from the Cypriot president, who was willing to preserve the image of the island as a financial center; as if the confidence of dirty money could be a sustainable comparative advantage for Cyprus! The stupefying thing is that the other euro governments accepted this clause even though it was financially dangerous and certain to be rejected by the populace and its representatives. In following the relief produced by the substance of the new agreement, the Dutch finance minister and chairman of the Eurogroup announced that the Cypriot treatment was great news because it showed that bank depositors may be expected to contribute to future bailout packages. However this is explosive and potentially as damaging as the PSI initiative adopted at Deauville. There was immediate backtracking but this reminds us that the whole process remains fragile. All this being properly considered, we should examine the ongoing euro crisis along a different narrative.

And after having described the situation in Cyprus as potential chaos in the waiting, experts now explain the absence of collateral effects by referring to the July 2012 famous commitment of Mario Draghi.

What the above mentioned facts demonstrate is that markets and people outside of Cyprus adopted (at least until the Dutch minister’s proclamation) a much calmer view than specialized commentators. And after having described the situation in Cyprus as potential chaos in the waiting, experts now explain the absence of collateral effects by referring to the July 2012 famous commitment of Mario Draghi. This is at best an excuse for not exploring other explanations and at worst a superstition for placing too much power in his mouth. Rather, two broader facts should be emphasized:

First, looking outside the eurozone, the euro has remained as attractive an international currency as before all the vicissitudes of the sovereign debt crisis despite all the aggressiveness on part of the international financial press. The exchange rate with the dollar constantly remained close to 1.3— a rate which reveals an over-valuation of the euro; such stability is surprising given all the daily announcements of its forthcoming collapse. This fact, which has never received proper attention, at the very least proves that the euro has always remained as attractive as the dollar. After all the drama we have gone through, there was little chance that the Cypriot episode will change this global perception of the euro.
Second, within the eurozone, there is an underestimated willingness to stick to the euro as the currency of the European continent. Austerity measures are never popular and governments that adopt them have been punished in Greece, Spain, France and Italy. Nevertheless, this is the natural product of democracy, and when it comes to the explicit question— “do you prefer to stay in the eurozone, with its mechanisms and constraints, or move on your own?”— the popular answer everywhere has been “we stay”. This is what popular votes have proven in Ireland, Greece and Spain, as well as in Germany where local elections have regularly promoted euro-friendly candidates.

So what can we conclude from the recent crisis in Cyprus? The first conclusion is that Cyprus will pay a high price for exiting a dramatic situation and securing access to eurozone support; no other feasible deal was better than that one at that particular moment. Second, we have witnessed once again the willingness of the eurozone to stay the course, and its ability to design imperfect but feasible compromises, which is not so bad when compared to what’s going on in Washington. In brief, this is another Euro-solution. However, Cyprus is certainly not the last challenge confronting the governments and people of the eurozone. In that sense, the most problematic lesson from this chaotic week is not financial but political. The future of Europe more and more lies in the hands of Germany and there is no place here for accusing the Germans of egoism. Financially speaking, they have moved forward at every step during the last three years and they are the ones that repeatedly take the biggest risks. There is no question that Germany has a prominent voice and that it defends its financial security before entering into an agreement. This is what should have been expected and this is what we have seen with what happened in Cyprus. Looking forward, the bigger problem facing the eurozone is the urgent need to design a macroeconomic policy that will spur a return to growth for the region. On this issue, there is still no visible Euro-solution and that could prove to be the biggest risk facing Europe.

Authors

Jacques Mistral

UK's Euroscepticism Could Cost Britain Power

Thomas Wright — Wed, 27 Mar 2013 00:00:00 -0400

The idea that Britain should use its influence to remake the European Union is not an unreasonable one. There is a strong argument that the EU is on an unsustainable path — the eurocrisis is creating a dangerous divide between the periphery and core, the eurozone is encroaching upon the EU, there is a yawning gap between the people and their leaders, and Europe has much to do if it is to be competitive in a world dominated by the US and China. Britain is a country with the diplomatic skill and heft to move the EU in the right direction.

Unfortunately, this idea is not on the table. What prime minister David Cameron has offered is a referendum that strikes many international observers as diplomatically irrational.

Regardless of the pros and cons of membership, the four-year wait till a vote is held creates immense uncertainty about the British economy and Britain's role in the world. Investment decisions, diplomatic engagements and countless other initiatives will be placed on hold as long as it is unclear whether Britain will be in or out.

However, there is an even greater risk with the prime minister's approach. It is much more likely to lead to an exit than his publicly stated position suggests. Cameron has promised a vote if he renegotiates the terms of Britain's membership with the European Union. This way, he can have it both ways — rail against the status quo, but claim he is in favour of membership.

By implication, he has not promised a vote if he is unable to renegotiate the terms of membership. This is a rather gaping loophole. From the perspective of the rest of the EU, the easiest path is to refuse to renegotiate — hence, no referendum and no risk of Britain leaving. And it appears as if this is exactly what is happening.

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Authors

Thomas Wright

Publication: Politics.co.uk

Image Source: © Reuters TV / Reuters

Portugal and the Euro Area: A Conversation with Portuguese Minister of State and Finance Vítor Gaspar

Tue, 26 Mar 2013 10:00:00 -0400

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March 26, 2013
10:00 AM - 11:30 AM EDT

Saul Room/Zilkha Lounge
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

In 2011, Portugal suffered a sudden stop in international financing, triggering an abrupt adjustment process. As the crisis in the euro area continues, Portugal continues to feel its impact, with the recession entering a third consecutive year in 2013 and unemployment reaching record highs.

On March 26, Global Economy and Development at Brookings hosted a conversation with Portuguese Minister of State and Finance Vítor Gaspar on the challenges Portugal faces as the euro area looks to find a path toward recovery. Mr. Gaspar was appointed minister of State and Finance in June 2011. Gaspar is also a professor of economics, having taught at various Portuguese universities. He holds a Ph.D. in economics from Universidade Nova de Lisboa. . He was the head of the Bureau of European Policy Advisers at the European Commission from January 2007 to February 2010. From September 1998 to December 2004, he served as the director-general of research at the European Central Bank. Prior to that, he held various high ranking positions in government and at Banco de Portugal.

Brookings Managing Director William Antholis moderated the conversation.

Video

Audio

Portugal and the Euro Area: A Conversation with Portuguese Minister of State and Finance Vítor Gaspar

Transcript

Transcript (.pdf)

Event Materials

A New Business Model for Cyprus

Javier Solana — Mon, 25 Mar 2013 00:00:00 -0400

Once again, Europe has peered into the abyss. But the tentative agreement between Cyprus and the troika (the European Commission, the International Monetary Fund, and the European Central Bank) probably means that the worst has been avoided. Big losses for large depositors in Cypriot banks will now be imposed, and the country’s second-largest bank will be shuttered. Looking ahead, however, Cyprus has the means not only to recover, but even to heal its longstanding division with the Turkish-backed statelet in the north of the island.

Cyprus, of course, is just the latest country to be hit by the economic crisis surging through the Mediterranean. For years, Cyprus had an immense banking bubble, with the sector’s assets estimated at roughly seven times the country’s GDP, as foreign money poured into a tax haven within the eurozone’s secure environment.

The design of the bailout has been shaped both by domestic pressures faced by eurozone leaders and by the exceptional nature of the Cypriot banking bubble: many European leaders suspect that the island had become a money-laundering center for Russian individuals and entities, which pumped an estimated one-third of the €68 billion into the country’s banks. Regardless of the details of the ultimate deal, the risk is that the ghost of Russia’s bailout of Cyprus in 2011 could provoke severe side effects across Southern Europe, both for governments’ borrowing costs and for small savers.

Nevertheless, it is imperative not to lose sight of some very valuable assets that Cyprus holds – assets that could mean the country’s economic salvation.

Read the full article »

Authors

Javier Solana

Publication: Project Syndicate

Cyprus II: Considerable Improvement, but Serious Risks Remain

Douglas J. Elliott — Mon, 25 Mar 2013 10:55:00 -0400

We can heave a sigh of relief about the revised Cyprus deal. Early this morning, Cyprus, the various European authorities, and the IMF found common ground on the outline of a deal that is much better than the very flawed agreement of the previous weekend. At the same time, the earlier botched proposal will carry some long-term costs and the actions taken now, while necessary, create real risks of their own.

The best news is simply that an agreement of any kind was reached, allowing European support to flow to Cyprus and preventing, for now anyway, the possibility of an exit from the eurozone. It is also very good news that insured bank depositors in Cyprus will be protected after all, eliminating a terrible precedent with repercussions across Europe. Further, there are real advantages to inflicting large losses on the uninsured depositors and the bondholders of the two largest Cypriot banks. This is by far the strongest message Europe has ever sent that people must pay attention to the strength of the banks with which they deal. It brings the hope that market discipline will finally be a significant aid to outright regulation in ensuring that European banks act prudently at all times.

The first risk is the flip side of passing losses on to those who put their money in banks. In practice, Europe has a long tradition of protecting all depositors, not just the insured ones, and, in most cases, the bondholders as well. For example, the much vaunted, and highly successful, Swedish bank rescues included guarantees for all liabilities. Over time, in reaction to this, there may be major flows of deposits from the weak banking systems in Europe to the stronger ones, further exacerbating credit crunches in the periphery. The ECB and national central banks can offset these flows, but only with further distortions that carry costs of their own. Weaker banks, and those in weaker countries, will find their borrowing costs rising on bonds as well, as investors take heed of the lessons of Cyprus. Even banks in strong countries are likely to see costs increase over time, as depositors and investors react to this major change in regulatory regime. These costs will generally be passed on to customers, potentially slowing economies down at least modestly further. (The ECB can partially counteract this effective tightening of credit conditions, but it is already close to “pushing on a string”, hitting conditions where it is difficult to ease further and have any effect.)

The second problem is that we cannot “unring the bell” of potential hits to insured depositors. The first Cyprus deal raised the real possibility that insured depositors across Europe could lose money if their banking systems and national governments became too weak. The strong reactions to this, and its complete elimination from the final deal, reduce this damage considerably, but it will remain in people’s minds. If there is another serious banking crisis in a weak eurozone nation, depositors may be more prone to move their funds to safer banks and safer countries, in a classic bank run.

The remaining risks are about Cyprus itself. The economy will be severely damaged by the deal and the turmoil around it. A severe recession will be exacerbated by the losses taken by businesses and others with large, and therefore uninsured, bank deposits, and by the restrictions on banking transactions that may remain for some time. Confidence, of course, has been badly shot. Further, nearly a fifth of the Cypriot economy consists of financial services, a sector that will shrink very sharply now. There will also be other conditions imposed on Cyprus as part of the larger agreement with the eurozone and the IMF that will likely hurt in the short run even if they may be for the best in the long term.

It is going to be extremely difficult for a fast-sinking Cypriot economy to produce the results necessary to hold the country’s debt down to a sustainable level. Thus, we are being set up for a future round of tense negotiations to either bring in more eurozone support or take drastic actions such as a bond default, similar to Greece’s. Such a default would carry at least some contagion risk for the rest of the eurozone, unless the larger crisis is essentially resolved by then.

In short, there is no cause for real celebration, but there is reason to feel relieved that disaster was avoided and some of the ill effects of last week’s debacle have been erased. The initial market reactions seem about right; they are up after the weekend’s news, but not soaring.

Authors

Douglas J. Elliott

Is Russian Peter Being Used to Pay the Cypriot's Paul?

Bessma Momani — Thu, 21 Mar 2013 13:46:00 -0400

Cyprus, a small island of one million people, has very large banks. In fact, the banks have the wealth of eight times the entire Cypriot economy.

Obviously, this doesn’t add up and that’s because Cyprus has become an offshore financial centre, offering a haven for money transfers, money laundering, and Internet banks. Foreigners from Russia, worth nearly €20 billion, have been attracted to these lax rules in setting up bank accounts that accompany low corporate tax rates.

Not surprisingly, 40 percent of all Cypriot bank deposits are foreign owned making them an easy target to raise funds. But there’s another reason that the Cypriot government has chosen this route. The perception of European Union (EU) countries is that some of these Russian depositors may be shady characters linked to either criminal activity or government cronies that deposited corrupt funds.

Few democratic EU creditors, particularly the Germans who face an upcoming election, want to bail out Cypriot banks to safeguard Russian assets.

Few democratic EU creditors, particularly the Germans who face an upcoming election, want to bail out Cypriot banks to safeguard Russian assets. Not especially when the EU already has a less than friendly relationship to strongman Putin, who played musical chairs with his now prime minister and who unabashedly supports the despised Syrian regime.

The troika creditors, the EU, the International Monetary Fund and the European Central Bank, will only give Cyprus money needed to recapitalize its distressed banks if it can reduce their overall debt burden to 60 percent of GDP and raise €5.8 billion. There are few state assets or valuables that can be used to raise the funds needed.

Usually, governments have forced its own creditors, like those holding government bonds, to take a “hair cut” by then returning less on the interest or principal that was promised. Raising taxes on citizens to generate government income has been another common route taken in previous EU bailout. But with such a small population, this isn’t an easy way to raise the necessary funds.

The Cypriot plan would have required all depositors to forgo nearly seven to 10 percent of their deposits toward the government debt write-down.

This levy presents a first of its kind in managing the contemporary EU debt crisis; in 1990, Italy had a similar bank tax but the amount was less painful at 0.06 percent. The Cypriot plan would have required all depositors to forgo nearly seven to 10 percent of their deposits toward the government debt write-down. This measure would face a number of potential legal contentions, as the EU passed a 2008 depositors insurance law that guaranteed up to €100,000 in each bank account.

This is why the Cypriot legislature, sitting for only a month, rejected the plan and may reconsider the universal application of the government levy and instead apply this only to those accounts over €100,000. Protecting these smaller mainly domestic depositors, this might then raise the percentage on large, presumably foreign, depositors to even 15 percent. No wonder Russian President Putin said this was “unfair, unprofessional and dangerous.”

For the first time, the small island of Cyprus, with less than two percent of the European economy, might be shifting the burden or passing the buck on to Russia. Wealth and international politics at play...

Authors

Bessma Momani

Publication: CIGI

What's the Big Deal about Cyprus?

Michael W. Klein — Wed, 20 Mar 2013 00:00:00 -0400

Editor's Note: In an interview with the GlobalPost, Michael Klein explains what made the terms of Cyprus's rejected bailout controversial and this situation might mean for the rest of the eurozone.

Why did the Cyprus bailout package cause such uproar?

With insured deposits, there is a guarantee that there will be no confiscation of depositors’ money. Even just the fear of a bank run can lead to a bank run. In the 1930s, none of the deposits were guaranteed by the government and that led to bank runs, which in turn deepened the Great Depression. Government guarantees on insured deposits took away most of those fears.

[The Cyprus bailout] is a little bit of crossing the Rubicon to start charging depositors a tax on what they perceived to be insured deposits.

The real concern is not so much what’s going on in Cyprus, but if this becomes a method by which bailouts are funded. Then, there is concern that this could lead to bank runs all over Europe, as other countries’ banks are imperiled.

If the same kind of thing happens there, it could be really problematic.

What are the potential risks of a bailout that includes taxes on depositors’ accounts? Is it a bad precedent to set?

I think it is a bad precedent. It doesn’t distinguish between bad banks and good banks. And it means that deposit insurance might not mean what they say it means.

The bank run is an infrastructure thing because then banks start to shut down and it starves the economy of credit. Historically, we've seen that in situations where banks fail, the depressions that ensued were deeper, more severe and more protracted than recessions that arose for other reasons.

Even though concessions were made to let small depositors off the hook for the tax, the bailout was vetoed by the Cyprus government. What does this mean for Cyprus and for the rest of the Eurozone?

There’s a problem with letting small depositors off the hook logistically, because what could happen is people could split up their deposits and all of a sudden big depositors could look like small depositors. Presumably they have information beforehand, so people couldn’t do that. If you had a deposit in excess of a 100,000 euros before, you can’t hide it.

For Cyprus [a veto] means they have to go back to the negotiating table. Either they get cut off from the bailout funds or there’s a realization on all parts that this was a problematic solution and they go back to the table.

The problem is though – people have been talking about this for a while now – if one country exits the Euro area, it could cause a cascade. People have not been focusing on Cyprus so far. People have been focusing on Greece, of course. If Greece were to exit, the concern is, ‘who’s next?’

If Cyprus exits… if they don’t get the bailout and they drop out of the euro, then the question arises again of who’s next. That question has always been one of the big issues in Europe. As market psychology moves against countries, the most immediate problem is that sovereigns have to pay, and everybody else has to pay, much higher interest costs.

These interest costs had been coming down and it seemed like things were settling down as compared to a year or two ago, but now the question arises about whether this will cause interest rates to spike up again.

The Dutch finance minister and Deutsche Bank’s Chief executive have said this is unlikely to be a model for other countries. Why was Cyprus a special case? How would this affect other vulnerable countries like Spain and Italy?

Cyprus is seen as a financial center where the banks are outsized given the size of the economy. There’s also an issue with a lot of foreigners parking their money in Cyprus. But, nonetheless, people might not necessarily perceive it as a special case.

On Monday morning when banks opened in Spain and Italy, there were no bank runs. Some people cite that as evidence that Cyprus is a special case. On the other hand, it could be the case that the tinder has gotten a lot drier and a spark can do a lot more damage.

The fact that it hasn’t happened yet doesn’t mean it’s not going to happen.

Greece is still a real problem. Greece doesn’t show signs of recovery. There has been some shift in other countries, but they’re operating in an environment of very weak growth for Europe as a whole. In the last week or so, Germany has talked about not providing for the stimulus to its economy, which means that Germany’s not going to be an instrument of growth for Europe.

The three problems in Europe are the sovereign debt crisis, the banking crisis and slow growth. They’re all interconnected with each other. You can’t solve one without solving another.

The banking crisis, part of it has to do with non-performing loans, so slow growth affects the banking crisis. The banking crisis means that credit is less available, and that contributes to slow growth. Slow growth makes tax receipts lower for the sovereigns, so their debt crisis is worse because the cyclical part of their deficit is large. And then banks hold sovereign debt, and when that looks more imperiled, the banks are more imperiled. All these three things are very interconnected. You can’t really solve one without solving the other two.

So far they seem to have pushed austerity measures as a way of dealing with the Eurozone crisis. Do you think that’s the wrong approach?

In a lot of countries, ultimately there has to be a scaling back of government spending and a way to raise taxes. However, in the midst of a deep, deep downturn, austerity just makes the situation worse.

It’s sort of an extreme example of what’s happening in the United States. In the United States, we seem to be coming out of a recession, and the government’s deficit has been bigger because of the recession. If we started cutting the deficit right now, we would provide very strong headwinds to the recovery.

In Europe, it’s like that but much more severe. They’re in a much worse situation. These countries are just stuck in a deep cycle of austerity and slow growth, which means further deficit problems, which raises more demands for austerity, and so on.

It seemed like things were getting a bit better but this is raising concerns so the Eurozone crisis may be back in the headlines. There may be second round effects around what’s going on in Cyprus, especially that they’re willing to cross the Rubicon now.

Once you start not distinguishing between banks that are better off and banks that are worse off, once you say insured deposits are not really insured and are open for taxation, that leads to a lot of concern about the banking system. It might start to show up in other countries as well.

Authors

Michael W. Klein

Publication: GlobalPost

If Europe Doesn't Stand Up After Cyprus

Carlo Bastasin — Wed, 20 Mar 2013 00:00:00 -0400

Editor's note: This article was originally published in Italian by Il Sole 24 Ore.

Like what happens to less intelligent creatures, there was also a sudden disavowel of paternityin the Cypriot mess. No one in Europe admits responsibility for the project of forced confiscation on all bank deposits, also the more modest ones. A proposal that, while necessary, will not survive to its temerity and is putting in danger the stability of the Euro area. On the other hand, the confusion about responsibilities is due to the unbalanced decision-making mechanism that has characterized the last years of the European crisis.

Facing an emergency, Berlin sets the political priorities; the Eurogroup decides the least tricky technical solution for the governments; the heads of state communicate the decisions to their citizens, attributing the responsibility to Brussels; finally the EU commission and the European Central Bank execute orders, at times sanctioning countries and almost always taking the blame.

The anti-European short circuit is assured because the level at which decisions are made is never at the level where democratic choice happens. In fact, the problems arise when a National Parliament meets, as happened yesterday in Cyprus. The citizens circle the Parliament and the parties accuse Brussels or Berlin, also hiding the national responsibilities.

Contrary to what is said, for example, the confiscation of Cypriot deposits is a national fiscal measure. It does not violate the insurance of balanced bank accounts in the EU, that spring into action when a bank fails. It is a tax that will be discussed at the European level and that is conditional on European support, but will be done at the national level. However, in a certain confusion of roles and in a certain mess of solutions it was easy for the government and the Cypriot Parliament to turn it down like an error committed entirely by others.

Clarifying to citizens the allocation of responsibilities between Cyprus and countries in the Euro area is difficult because the transparency of the European decision-making process is really poor: there exist no memos of the Eurogroup meetings, whose last leader was chosen because he was not very garrulous; the heads of government then agreed bilaterally over telephone; above all a true public confrontation does not exist, but there are 17 members and 17 borders.

The only common thing is the confusion of blame that, if it was not tragic, would be funny. Try to follow the thread: on Sunday, all accused the German minister Wolfgang Schaublre for the proposal of forced withdrawal. Schauble however claims that he is opposed, with the IMF, to withdraw on small Cypriot money savers. Berlin, in fact, unloads the responsibility on the government of Nicosia, that (for fear of a bank run) did not want high withdrawal on the rich. But it accuses also the EU Commission and the German member of the ECB, Joerg Asmussen, who had observed that a bank run was already happening and that they needed to freeze accounts. Cypriot president Anastasiades retorts that he was blackmailed by Berlin and by the ECB, which would have cut funds that keep the country's banks alive. The Commision denies having defined the proposal and finally the ECB denies directly and categorically: the blame is on the political negotiations held in Brussels. All the institutions, however - IMF, EU, ECB - are together on having had to put a limit of 10 billion on the assistance to Nicosia. Officially to not bring Cypriot public debt to over 140% of the GDP, but in reality to appease crediting governments and to limit their expenditure. Are you lost? You have reason to be.

But we are still far from having unraveled the tangle. Behind the negotiation with Cyprus, there are in fact others that are more complex. The most important regards relations with Russia which leads with around 20-25 billion Euros deposited in Cyprus, one of the most obscure financial markets in Europe. To not touch the small Cypriot depositors, there is a need to withdraw 15-16% of big deposits. But Moscow had just loaned 2.6 billion to Nicosia, which now, pushed by European partners, they have to withhold like a tax on Russian deposits.

The European relationship with Russia is based on big interests and huge suspicions. Berlin first wants to impose on Cyprus the closure of financial channels with Moscow. It is a negotation of such implications from having to be leader of leaders of government or of ministers abroad rather than financial ones. But Europe has no real common foreign policy, least of all in the Euro area. The result is that Cyprus will end up asking Moscow for help. Hypothetically, it could end by depending on Russia so much that it detaches from the Euro area, opening the gate to the first devastating exit of a country from the Euro. Yet a European political initiative was possible: a battle against off-shore finance would collect the consensus of the vast majority of European citizens and would be difficult for Cypriots, facing European support, defending the abuses of their banks. As is seen, whether in foreign policy or in institutional assets, denouncing the lack of European political unity is anything other than an appeal to abstract principles of a dated Europeanism. However the Cypriot crisis shows also that the will of Europeans to help themselves in exchange for common policy (for example the fight against money laundering) is exhausted and weak bringing into doubt also the solidarity that will be indispensable to constitute a bank union. That is the project with which is necessary to avoid, like in Cyprus, a banking crisis sinking a country. A project on which depends the survival of the Euro.

It is estimated that Cyprus has until June to choose to form a tie with Moscow or fail. A somewhat long time that may keep the Euro area in check and may also coerce it brutally to change its strategy one more time.

Authors

Carlo Bastasin

Publication: Il Sole 24 Ore