Greece, Spain, France...whither policy in the Eurozone?

Ireland, Greece, Portugal (sort of)...yup, all struggling... at the 2012 European Football (Soccer) Championships. A nasty parallel to the struggles afoot in these peripheral Euro economies, although at least Spain is bucking the trend – not least after their 4-0 thumping of Ireland last night.

Should be interesting indeed should one of the Iberian teams face off Germany in the Quarter-Finals or beyond!

Spain’s gift of utterly watchable total-football is equally utterly at odds with the sinking state of its economy and banking system that finally led to its government seeking and getting EU Aid to the tune of €100bn.

Connoisseurs of footy will know that perhaps the similarities are more than meet the eye if and when the debt-fuelled success of its two pillars of Barcelona and Real Madrid are factored-in and which may also see come-uppance when UEFA’s Fair Play rules come into play with the aim of tying expenditures to revenue and without recourse to bailouts. Sound familiar?

There are several questions that immediately come to mind from events in the last week and in the coming days:

1. Greek Elections on Sunday. Is this really a Referendum on the Euro? Is it the Lehman-moment of 2008 when US policy action went into over-drive to solve banking and sub-prime problems in the US?
2. Does the aid for Spain do anything beyond the short-term fix?
3. What does the relatively softer conditionality for Spain imply for the existing recipients, particularly Greece?
4. A lot of focus on Greece, but what does the outcome of the French parliamentary election presage in terms of European polity?
5. What does this mean for the overall health of the Eurozone and wider EU economy and the policy mix required?

Greek Elections

Whatever the outcome, I don’t see this as a watershed moment. As I’ve written before, this is the “prisoner’s dilemma” problem where nobody gains by a Greek Exit or Grexit. Moreover, there are legitimate Greek demands for a stabilisation programme that is realistic and feasible in terms of the conditionality as well as understandable requirements by donors, particularly Germany, for credible reforms in Public Finances and structural adjustment.

Spain et al

In short, this was expected but it does leave a lot of questions. Anyone familiar with EU negotiations and the pattern of recent years will appreciate that we are likely at the starting point of what will be the final size of the financing required for Spain – particularly if we start to see an outflow of non-Spanish capital in the way experienced in Greece.

The deployment of the EFSF monies for recapitalising Spanish banks through its recapitalisation tool or fund is perhaps not surprising. But is this liquidity support sufficient or are we facing a solvency issue as in Ireland and a likelihood of larger liquidity support from a new liquidity splurge by the ECB complemented by further official aid and budgetary support? Are we facing the likelihood of debt write-offs in the end –something that may explain the response of bond markets there.

Conditionality

Anyone familiar with programming aid programmes and budgetary support is familiar with the prima-facie requirement that for a credible programme the conditions must be relevant and feasible. In practice political considerations tend to dictate the design and this is essentially what’s happened in every programme to date in the Eurozone.

The evolution of the Euro crisis to include Spain means that the ultimate design of the package for Spain will in turn lead to re-design of programmes for Greece, Ireland and Portugal. The problems in Cyprus means that we are not far off a programme there.


Implication of French Elections

To my mind this is perhaps the more interesting of the elections taking place. The noise since the start of his presidency is decidedly more lower but the likely victory of the socialists for the French Assembly will leave Mr Hollande in a very powerful position to push for a more expansive approach – both in France and within the Eurozone - for governmental intervention to expand Aggregate Demand.

Mr  Hollande may well become the lynchpin for a coalescence of the southern Euro-members seeking a more growth-centric approach that reverses the fiscal compressions of the last 3 years.

Implications for Policy Responses

Short-term measures to boost investment via the EIB and faster use of Cohesion and Structural Funds are sound measures but are no panacea without an overall framework (there is plenty of evidence of poor impact, lack of sustainability and simple lack of value-for-money from previous internal structural funds transfers within the EU).

In particular the framework has, ultimately, got to be about the overall design of the Euro based on the overall fiscal-monetary mix in the Single Currency zone.

Real convergence of Public Finance Management is a sin-qua-non for the ultimate functioning of the Eurozone in the long-term. This in turn will require not only the co-ordination of national fiscal plans but also the rigour of financial controls and audit channels and the related issue of value-for-money –meaning structural/microeconomic reforms: governance reforms (re-design of public administrational functions with a focus on much smaller states, much more transparent and fairer public procurement, more effective competition policy,...) as well as convergence of norms in social care (eg pension age) and banking standards.

Without this convergence there will always be the risk of moral hazard for the debtors to seek ex-post aid or simple arbitrage for  a country with a much lower pension age (say Greece v Germany) or much looser bank regulation.

And thus we reach a conundrum. A lot of this was discussed before the design of the Euro but remained theoretical. Now that we are in the middle of the Euro-crisis the Germanic position that forthcoming financial assistance or pooled fiscal liabilities would be acceptable but only if the re-design ensures that fiscal competences of soverereigns are too constrained or pooled cannot be shirked.

Current measures for a common deposit facility for banks and a single supervisory node are steps in the right direction for this overall needed convergence. The political reality of the 17-State Single Currency Zone however means that we will continue to see a chess-game of those who favour a ceding of national fiscal sovereignty as the eventual cost of co-sharing access to the German and Nordic exchequers.

Don’t hold your breath...

Eurozone and Bank Runs: Deja Vu or Self-Fulfilling Prophecy?

We are now clearly in a new and troubling phase of the Euro-crisis. There is, like most things in life, a sense of diminishing returns to continued reference to “crisis”, “precipice” and similar doomsday pronouncements when in fact the Eurozone has continued to survive. And accompanied with modifications to the monetary-fiscal mix through increased liquidity support, moves toward a Fiscal Compact and a firewall to help Euro-members.

And yet, there is a clear sense of a worsening situation as Spain has become the country in the headlights but with less-pronounced but equally serious issues facing other countries – from Cyprus through to non-Euro peripheral emerging economies such as Serbia.

Mass withdrawals are a natural reaction by savers who fear either devaluation (Greece), likely freezing of FX accounts following a possible Euro-exit/devaluation (Greece again) or mass panic due to uncertainty and lack of confidence (Spain, Cyprus).

There is ample evidence of the outflow or transfer of a wall of money from Greece to safety in the northern Euro-zone countries or conversion to assets (just ask real estate agents in London and elsewhere).

We are now seeing the same in Spain with reports of mass withdrawals, which in turn feed into further bouts of risk-aversion aka the Mary Poppins moment.

And we know from the history of bank runs that contagion is not a linear process and no one can predict when and if the speed of withdrawals might accelerate and become a systemic crisis – both within the southern Eurozoners – but also to other Eurozone countries and to other non-Euro states such as the UK, or indeed to the ring of emerging economies ring-fenced in 2009 by the Vienna Agreement put-together by the EBRD.

We also know from historical bank runs that the role of the lender-of-last resort is vital, coupled with confidence provided through deposit-insurance.

Although the ECB has ramped up liquidity in recent months to Eurozone banks, a formalisation of this indirect fiscal liability is not forthcoming until and unless the Fiscal Compact becomes a credible reality which in turn allows net payers – particularly Germany – to feel that it is not going to be dumped with toxic and limitless uncontingent fiscal liabilities.

And the same argument applies for a common deposit insurance scheme.

Access to firewall financing, albeit do-able, would not itself tackle the core cause behind the bank solvency and attendant structural fiscal deficits in Spain – as well as other southern Eurozoners.

A cul-de-sac?

Potentially. But Spain’s volte-face in recent days toward reluctant acceptance of the idea that national budgets should be approved in Brussels highlights that there is no alternative when creditworthiness is declining, access to markets increasingly expensive and unsustainable and alternative policy options unavailable – including its first attempt for a domestic policy response of forced mergers between weak banks and cajas.

We are entering the central phase of the Euro crisis and I expect it to continue well into 2013 (the German Bundestag election is due by October 2013) and probably into 2014.

Spain will need external aid. This means a Programme – likely one based on the Troika-model for Greece.

Cyprus will likely need one too, given that largesse from Moscow is unlikely to continue and given its vulnerability to Greece, particularly through its banking system.

And what about Malta? How about Italy? Shhh but how about France?..

Very soon we may find that the entire flank of the Eurozone south is having to undergo forced structural adjustment – although hopefully on a more realistic macroeconomic framework than was the case for Greece.

Will such external programmes be politically feasible? Would they come with capitalisation for banks and in the scale that might be required? Would this be sufficient to give the Fiscal Compact credibility and in turn sufficient guarantees for Germany to agree to mutualisation of sovereign risk?

The risk of Spain entering the maelstrom of the crisis has indeed been a déjà-vu. Spain is too big to save through bailouts and so we may have reached a critical point in the crisis.

Iterative policy responses from Eurozone politicians may be a natural response to domestic politics but the very real threat of bank runs in Spain and possible spillover to the north (witness recent de-ratings for German and Austrian banks), however small the risk,  could well become a self-fulfilling outcome.

In the short-term, confidence in the Spanish banks and Spain’s “irrevocability” with the Euro will require external support and I expect the IMF to play a key part.

However it is vital that any programme focuses beyond the narrow prism of re-capitalization of banks and fiscal reforms to also focus on measures to put in place