Thursday, June 23, 2011

Lack of transparency and honesty in the EU on bailouts

The Eurozone crisis is largely a hidden banking crisis rather than a currency issue per se. Europe has a chronically undercapitalized banking system of which the Germans are among the largest offenders. EU politicians have addressed this as a liquidity problem with its Periphery in order to hide these issues and avoid any open discussion on the ultimate costs involved in transferring risk from the financial industry to public balance sheets and ultimately to EU taxpayers.

The EU elite and ECB want to deny they face any serious long-run problems. They prefer to address the problems of Greece and other EU countries as a liquidity crisis, ruling out debt renegotiation because it gives the illusion to the EU public that their bailout loan schemes are only temporary and the money is recoverable with interest, so that various Eurozone members can secure Parliamentary approval.

In the case of Greece, they are forcing the country to go to about 170% or 180% o its GDP in debt. Greeks to dig themselves out on that path, will have to put maybe 7% to 10% of GDP in just paying interest. Meanwhile the wage and price deflation austerity are causing massive economic dislocation and unemployment that is shrinking the GDP. Latvia, for example, achieved only a nominal devaluation at the price of severe GDP compression and a large rise in external debt.

In the current debate, there are two opposing camps. The establishment camp is the ECB, EU elite supported by the EU financial industry. They want to avoid any debt restructuring or default event and kick the can down the lane with public money country bailouts that repay the private creditors on schedule. They argue debt renegotiation would be a default event risking uncontrollable contagion and banks need more time to build up their balance sheets.

What they hide deliberately is how they will deal with their huge public money holding of debt stock of insolvent countries like Greece with unsustainable debt loads. Will they eventually write off huge amounts of this debt or hold these countries in a permanent debtor's prison in years of economic stagnation?

The opposing camp led by Nouriel Roubini is that official view is in self denial and increases the risks of a large, messy disorderly default with uncontrollable losses. Roubini argues for Greek debt restructuring now to remove the market pressure from default risk with debt relief to facilitate the structural reform. Politically it will be easier to sell this to EU voters when they see the shared sacrifice of the EU financial industry.

Wharton's Franklin Allen, who organized in April a seminar in Florence, argues that leaving the Eurozone would be a better option for Greece leading to a speedier recovery and forcing a debt renegotiation. Economists like Paul Krugman point to Iceland and how they have recovered nicely after default.

No comments:

Post a Comment