Follow by Email

Thursday, August 1, 2013

Seeing the erred ways of my thinking... (11)

"The idea of a common currency union is a big mistake, an adventurous, reckless and mistaken goal which will not unite Europe but, instead, divide it"
Lord Dahrendorf, 1995.

Since I started this blog, I have tried to be as self-critical as possible; taking differing views into account; pondering them; learning from them; incorporating them into my own views. This is my 11th effort to recognize the erred ways of my thinking - and it is a major one!

To make it short: I now believe that Lord Dahrendorf was right. Right not only then but, even more so, today.

My blog has focused on Greece; I have more or less ignored the situation in other countries of the periphery (and I have not paid enough attention to the German situation). Greece alone had made me optimistic. I had observed, on location, how a small economy which had totally collapsed could be successfully turned around in only a few years with the right domestic economic leadership and the right support from abroad (Chile in the late 1970s/early 1980s). And I thought the same could happen easily in Greece. Well, it's not happening in Greece because the country does not have the right economic and political leadership nor the right support from abroad.

I had started wavering in my position some time last year but I forced myself to remain optimistic. What has brought me down to reality?

There seems to have been an intensified discussion of late about solutions to the Eurozone (at least in the media and blogs which I follow). I particularly refer to two articles in Prof. Varoufakis' blog: Six Critical Responses to the Modest Proposal and James Galbraith on Europe (and the numerous comments to them). Those pieces were indeed thought-provoking!

However, the eye opener was the book "The Euro-Liars" by Hans-Olaf Henkel which I have just read. Henkel is a very provocative individual but one can discard his provocations. However, one should not discard his arguments!

Henkel's principal - and irrefutable - argument is, like Lord Dahrendorf said almost 20 years earlier, that the Euro does not unite Europe but, instead, it splits it. There is massive evidence today that this is so. In my view, it is of secondary importance to analyze who is to blame for that because that always leads to endless loop-discussions without results. It is far better to recognize reality. And, secondly, Henkel argues that the Euro not only limits (if not destroys) economic potential in the South but also in the North.

It is futile, Henkel says, to impose a currency which doesn't fit national cultures. Instead, national cultures have to shape their currency. The Euro, as it was designed, does not fit the cultures of countries like Greece, Portugal and Spain (Henkel also adds Italy and France!). Neither is today's Euro suitable for the North because it makes it too easy for Germany & Co. to export (much of the exports are courtesy tax payers because tax payers lend the funds so that the periphery can pay for imports from Germany & Co. Put differently, a massive export subsidy!). If Germany & Co. were not in the Euro, they would have to become even more innovative and productive to remain competitive in the world and their surpluses would most likely come down.

In his critique of Six Critical Responses to the Modest Proposal, the American Uwe Bott (Bott Consulting, NY; contributing editor to The Globalist) writes more bluntly: "There will be no resolution to this crisis until European policy-makers come to grips with fundamental economics. The Eurozone never was and less and less is an optimum currency area. In theory the flaws in the construct are fixable, in reality there is not enough time or political will. It is the inescapable consequence that the Eurozone must be dissolved. In applying the lessons of German unification onto the Eurozone, it becomes unmistakably clear that even a willing Germany could never pay the price to make monetary union in the Eurozone work. The price tag for such exercise would be exponentially greater than the cost of German unification. Moreover, the ability to freely migrate in order to mitigate some of these problems simply does not exist in the Eurozone given cultural and language barriers".

My original optimism about Greece was based on the following logic: a long-term economic development plan (at least for 10 years) would be necessary to build up domestic economic value creation (and/or repatriate it through import substitution); a shift of the necessary foreign funding from loans to direct investment by foreign private sectors in the Greek private sector; EU-incentives to facilitate that (such as guarantees for the political risk including a Grexit); possibly temporary 'infant industry protection' (incentivating the repatriation of monies held by Greeks abroad and/or limitations on capital outflows). This is not happening (and I no longer have the hope that it will happen) because the EU never thought in those terms and Greek leadership never showed the will or, more importantly, the capability to effect the necessary reforms.

As Prof. Galbraith argues, austerity alone is not the solution; neither is stimulus alone the solution. It would require a 'European Initiative' comparable to what the US government might do in a similar situation. A United States of Europe with a federal government? Who would elect that government? Would national governments appoint it or would voters Europe-wide elect it? A Finn campaigning for election in Greece? A Greek in Germany? 

The present EU as a role model for a future federal government? An EU which currently seems more outside of Europe than part of it? An EU which tells us which shape cucumbers must have; what kind of light bulbs we can buy; what kind of bathroom fixtures? Since I have about 10.000 qm of grass to take care of, I am particularly interested in the latest EU regulation which will tell me what type of machinery I can use during which hours of the day/week!

In short, an EU of self-possessed overpaid winetasters who regulate what must be done at the subsidiary level but who do not have one phone number which the US President could call on defense or foreign policy matters? If that is the price to pay for the Euro, the price is far to high! Europe is not a uniform continent. On the contrary, one of Europe's USPs is its diversity of nations, cultures, languages, mentalities, etc. etc.

But something similar to the above seems necessary if the Euro is meant to survive in its present form. Some people argue that Germany should assume more 'continental leadership'. That, however, ignores how many Europeans would be scared by that (most of all the Germans themselves). 

Dissolving the Euro in its present form would cause very significant financial losses to all. True, but are those losses which could be avoided or are those losses which are already there but not yet realized? 

The South has already paid much of its bill: unemployment; economic destruction; absence of future perspectives; etc. One could argue that it can't get much worse and that a departure from the Euro in its present form would actually be beneficial: the South would become more 'competitive' in financial terms and it could draw on the capital which it has sent offshore during the crisis. 

The North has, as yet, hardly paid any part of its bill. However, responsible accountants would have to book that bill as an 'account payable' and it is just a question of time when it will have to be paid.

So it comes down to operational questions: Who will pay for what part of the bill? What is the best mechanism for facilitating an orderly payment of the bill? Etc. One ought to be able to expect that a group of smart people would find a solution to that, if the EU were only willing to form such a group and give it a mandate.

Henkel makes an important point: it is not the deficit countries which should exit the Euro. That would be adding insult to injury. Instead, it is the surplus countries which should do that! There are various ways how this could be approached. Henkel proposes that Greece, Italy, Spain, Portugal and France should keep the Euro as it is (with France assuming leadership) and that the other countries should chose a new currency for themselves (Henkel proposes a North-Euro and a South-Euro). Some countries (Bulgaria, Romania, etc.) might want to join the South-Euro and other countries (CZ, Poland, Denmark, etc.) might want to join the North-Euro. Another alternative might be to introduce parallel national currencies. As I said, there are many alternatives (Merkel's 'no-alternative-position' is an inconsistency in and by itself).

I sympathize with Greeks & Co. going on the barricades for having been deprived of a future. I also sympathize with Germans & Co. who feel that they have been (and are being) taken for a ride. Is that because of the Greeks & Co. and the Germans & Co.? I severely doubt it! Before the Euro, the Greeks & Co. and the Germans & Co. had a rather good time together. It is the Euro which has put the people of the Eurozone against each other.

So, I admit defeat in my belief that 'European policy-makers would come to grips with fundamental economics'. They seem incapable of that. All those ideas which aim at solving the Eurozone's problems through generating aggregate demand or through a Modest Proposal (which otherwise sounds very interesting) are pipe dreams. They might work in the United States of America with a strong federal government but they are pipe dreams in a Europe of administrators, technicians and bureaucrats focusing on national interests, all speaking in different languages and different directions.

RIP Eurozone!

PS: previous posts in this series: P1, P2, P3, P4, P5, P6, P7, P8, P9, 10.


  1. As a German living and working in Greece, I cannot tell you how sad your most recent article makes me. You were always one of the few sources of hope that kept me optimistic about Greek and European politics and policies. Despite the ah so many faults and stupidities being done in Greece and elsewhere, the ignorance of reality by all sides, and the constant egoistic priority setting of politicians more interested in their re-election rather than working for the common good, I enjoyed your encouragement and most of all: your applied sense of reality, taking into account a Austrian/German point of view, while not forgetting that there also other mentalities.

    You run one of the few blogs that actually discusses Greece's problems (and Europe's / Germany's problems with Greece) and offering solutions without any trace of arrogance and without being patronizing.

    And even though I completely share your view about the lack of political will / economic expertise on both European and national level to work out a genuine, realistic solution and make this currency work, I always took comfort/hope in your analysis and seemingly undefiable optimism that there will be a solution without giving up the EURO.

    Having to read that you also have to concede and lost hope in a future for the EURO, really leaves me sad and makes me wonder how long before I will have to leave this fantastic country. If the EURO breaks apart - and logic tells me that there CANNOT be a structured, organised way, it will be messy, brutal and in some parts of Europe very very dangerous - it will be the end of European integration. The EURO might have been a mistake, but its resolution might be the even bigger one...

    1. I didn't mean to imply that I expected something to happen soon. On the contrary, I would expect the muddling-through will continue, particularly if there is a CDU/SPD coalition in Germany after the election. A litte debt relief here and some other gooddies there to appease tempers. The only thing is: the muddling-through gets more and more expensive as time goes one.

      A 'sudden surprise' could make a big difference. Henkel gave the (hypothetical) example that Finland could announce a Euro-exit a few days prior to the German election, and then what?

      More likely would be civil unrest in a Southern country. Greece might be a candidate when new measures have to be implemented in the fall.

      I think the real test will be when the French-German axis breaks. I don't really see how that can be avoided in the longer term. So far, the Germans have not really reacted to dirty words coming from the French socialists. But there has got to come a time when the German population begins realizing that they are working until age 67 so that their French neighbors can retire at 62. Wouldn't you think?

  2. Henkel's principal - and irrefutable - argument is, like Lord Dahrendorf said almost 20 years earlier, that the Euro does not unite Europe but, instead, it splits it.

    I won't read Hankel's new book, unless it gets translated.

    So a question - can I assume that Hankel's position today is not so very different to what it was in January 1998?

    That was when he along with Nolling, Starbatty and Schachtschneider put the case against the Euro in a 350 page submission to the GCC in Karlshrue. A position which they had formulated in the years following the release of the Delors Report.

    I think Anonymous in the first comment tells us why Merkel holds to her 'no-alternative-position'. The dismantling of the Euro will be a messy, brutal and potentially dangerous affair. She is doing as any good national leader would do, trying to protect her country from the noxious level of opprobrium that would inevitably ensue from the demise of the Euro.

    Was the failure of the Euro inevitable from the get-go?

    Probably, especially once the Soviet block collapsed. From then on Europeans - elites, nomenklatura, bourgeoisie, hoi polloi etc - all thought that all things were possible; as they looked out at the world through rose tinted glasses and down their supercilious noses.

    The fact that they failed to prevent the slaughter in the former Yugoslavia gives us a clue at how ill equipped the EU is to resolve a crisis. Sarejevo was bad enough, but had Clinton not intervened it might have soon looked as Grozny looked in 2002, or as Homs does in 2013.

    Actually I don't think the Euro will go away any time soon, it will keep going, maybe only just at times, for at least another decade or two. Change only occurs when the cost of doing the same is greater than the cost of doing the change - to which one might add - and the risk of inaction exceeds the risk of action. Witness Japan.


    1. Henkel was an enthusastic promoter and defender of the Euro until May 2010. He has always admitted to that and, in his book, he apologizes to all Germans for that. At least a non-politician is able to admit that he was wrong! When the no-bail-out clause fell with Greece, Henkel switched positions.

      I was not aware that Henkel had been a critic of the Euro back in 1998 and he certainly has made no reference to that in his book (neither in any of the talk shows and/or articles).

      I never thought that the failure of the Euro (or rather: the results we are seeing today) was inevitable. If there had been macro-economic guidelines for national economies similar to what Maastricht was for the budgets, and if they had been enforced, things would have turned out differently.

      Above all, if Basel-II had not allowed banks (or rather: even motivated them!) to run up huge portfolios of socalled risk-free assets (sovereign bonds), things would also have been different.

      In sum, if European leaders had not been so blindly bullish about the Euro (I remember near-celebrations that the Euro would soon take over the role of the reserve currency from the USD!), they wouldn't need to be so bearish now.

    2. Aaah, major mea culpa - I mis-read Henkel as Hankel.

      I recently found this transcript of what Wilhelm Hankel was saying in 2005 Why the Euro System Is Unsustainable - noteworthy is his use of simple words, avoidance of jargon and eu-lingo, and his prescience.

      My early doubts regarding the Euro were never economic. I don't know enough on that front. They were always about the EU's lack of political capacity to deal with crises and the mechanics of running a supra-state. Especially when it took on large-scale expansion, the wide-spread introduction of the Euro and deepening the union via the (failed) EU Constitution. Doing any one of those was a major task, trying to do all three concurrently bordered on culpable negligence.

      With regard to to enforcing rules and sticking to plans, the EU has a long history of not doing either for reasons of political expediency - its a political project, and has always been so.

      Three years ago I argued that perhaps the best thing for Greece would be to exit the Euro and even the EU. I no longer hold that view, Greece has probably lost whatever capacity it had to exert its sovereign rights - it's been reduced to an EU vassal state. Given the history of Greece over the paste two millennia perhaps that's not so surprising. And it accords with the Factual Constraint Theory that Hankel refers to in the interview I posted above.

      Sorry for the mistake


    3. Now I know whom you mean and I recall watching him - a long time ago - on talk shows. He has basically disappeared from the German radar.

      This is one of the points which Henkel makes in his book. Germany has free speech but when you dare to be politically incorrect, you disappear from the radar screen. Most people who have something to lose don't dare because of that or they split their comments into 'on the record' and 'off the record'.

      Thilo Sarrazin, for example, had to resign from the board of the Bundesbank, was almost kicked out of the SPD and is being mobbed wherever he appears (so he doesn't appear any longer). Why? Because he wrote a book with a lot of statistics and argued that the statistics showed demographic trends where the Germans were going to become fewer and the Turks more numerous in Germany. I haven't read the book but every 'serious' review of it claimed that it consisted of facts and not prejudices. But who cares about facts and discussing them when the Gutmenschen have convincing prejudices?

      Henkel is an exception but the only way he can stay on the radar screen is by provoking. He is in his seventies; had a superb career (after retiring as head of IMB Europe, he was for 2 periods President of the German Industrialists' Association) and he has the appropriate nerve system: instead of suffering from attacks, he continues to show that his attackers have no clothes... And that really gets people going!

      Another exception is Reitzle of Linde AG. He dared to say publicly that Germany should consider a Euro-exit. That, Henkel claims, got him a call from Merkel that his comments were 'not helpful'. But he repeated the comments. Reitzle is not provocative; he is one of the most respected German CEOs; he didn't retract BUT one doesn't hear him talking anymore.

      The thing about Henkel's book is not that he reveals anything new. All he does is to trace everything which has happened in the last 3 years and everything which politicians and others have said and argued, and why.

      Over a period of one year, you get the news in portions of 1/365th. By mid-year, you have forgotten what people had said at the beginning of the year.

      When you get 3 years in a condensed version of a couple of hundred pages, then you really get worried because you really become aware of all the lying which has taken place. At least, that's what happened to me. I really didn't learn anything new from the book. However, it became clear to me that when liars run the show, the show won't have a good ending.

  3. Dear Klaus,

    we live in a perverse world where the job of the lawyer is not only to ensure the legalities of an operation. His work is often to discover the loopholes that exist between two legal systems.

    Thus the eurozone splits Europe: money may move freely. Corporations with revenues approaching the size of the Netherlands have the power to abuse this to their heart's content. Both Starbucks and Google are a good example of this kind of abuse, an abuse that focusses on the weakness of Dutch tax law!

    Whilst it is good for the shareholders, these corporations seem blind to how these profits are generated.

  4. Klaus. Like it or not Varoufakis's Modest Proposal is what is going to be enacted, at the end of the day he has been educated and brainwashed in the system that has been created by the central bankers.

    The EU is going to start issuing bonds, this is where we are moving. Central bankers are businessmen, it is a logical progression for them to create another massive entity who their member banks can lend money to. Like I said they are businessmen.

    It does not matter if they send the people of Europe into poverty. It is the difference in wealth between people that makes someone rich and not the amount of money one has.

    The EU is a beautiful concept if it simply stopped at free movement of goods and people.

    The Euro as a de facto gold standard is a beautiful concept. A de facto gold standard massively restricts the power of governments and banks and puts the control of the currency in the hands of the people

    What we are seeing are deliberately created crises to poison peoples opinion of a gold standard type Euro and to influence people into believing that a fiat Euro currency is the solution.

    The sooner people realise that the crisis in Greece for example is deliberate and unnecessary the more likely they are to understand the solution of a gold standard Euro.

    Unfortunately people in Greece have been brainwashed into thinking more socialism is the answer, that massive government debt is a failure of capitalism. Greeks are nowhere near understanding the source of their problems and if anything they are falling more and more in love with their captors as time goes on.

    Klaus you are correct in giving up on the Euro. It is hopeless, better to have no Euro than an unaccountable Euro run for the benefit of a small clique. But as I said, we are going to get the Modest Proposal instead....

  5. Well there is 'Much Joy in Heaven at a Sinner who Repents', but maybe the question should be why you supported this idiotic idea in the first place and why it has taken so long for you to realize you were wrong. After all, it is not as if what we see today wasn't predicted. It was, by many Eurosceptics, who were vilified for their trouble.

    1. I thought I had explained in my article why I was optimistic about Greece. Have you not read it perhaps?

  6. "Henkel proposes that Greece, Italy, Spain, Portugal and France should keep the Euro as it is (with France assuming leadership) and that the other countries should chose a new currency for themselves (Henkel proposes a North-Euro and a South-Euro). Some countries (Bulgaria, Romania, etc.) might want to join the South-Euro and other countries (CZ, Poland, Denmark, etc.) might want to join the North-Euro."

    How convenient. Let's lump all the poorer countries together and dump them on France so that the rich countries stop being bothered. The surplus countries are as guilty as the deficit countries: rich German banks should not have gobbled up Greek debt assuming that just because the country is in the eurozone, it is a safe investment. Sorry but if you buy bonds, you take the risk of default. What happens is that nobody wants to take the risk of an investment anymore, but everybody wants the reward. If Greece had defaulted at the beginning, they'd have been in much better shape by now.
    Of course the euro can unite the continent but only if people want it to (the rich as much as the poor). The way things are going, it doesn't have many people defending it, so it will divide the continent further. Shame. But it's not the euro's fault, it is the leaders' fault. The world suffers from a chronic lack of leadership and vision. And hatred for the poor has reached levels that I for one had thought were buried in the past. People should never forget that circumstances can change for the worse quite quickly, for anyone.

  7. Klaus, once you have digested Henkel’s book, here a recommendation for a follow-up:

    Tatort Euro, by Prof. Starbatty, with an introduction by Hans Magnus Enzensberger, no less.

  8. Excellent article, Klaus.

    However, I have one small issue with one of your comments.

    You say:

    "Above all, if Basel-II had not allowed banks (or rather: even motivated them!) to run up huge portfolios of socalled risk-free assets (sovereign bonds), things would also have been different."

    I am afraid that is not so. The ECB is the exception and not the rule. Find me one other central bank that doesn't support the bonds of it's sovereign. Only the ECB does that (in it's uttermost stupidity). All other central banks on the planet make sure that the bonds of their sovereigns remain risk-free. Why? Because risky sovereign bonds would:

    "..reduce the value of the collateral that banks can use to secure wholesale and central bank financing. In private repo markets, sovereign debt accounts for a large share of total collateral, and participants are highly sensitive to changes in its riskiness. Sovereign debt is also widely used as collateral in central bank operations.."

    In other words, a risk-free asset class is necessary in order for monetary policy to function smoothly. If not, then we get the result of the Eurozone, where each member country witnesses different interest rates (with the ones being on a depression having the higher ones). That risk-free asset class is sovereign bonds; simple as that. Only in the Eurozone this doesn't happen, and this is why the Eurozone is disintegrating.

    1. I meant something else but I will first address your comment.

      What you say is true when it comes to the Fed because the Fed has a sovereign - the US government which raises federal taxes and emits federal bonds. The ECB does not have a sovereign! So when the ECB buys, say, Portuguese bonds, it would be akin to the Fed's buying bonds of California or Illinois. They are in the same currency area but they are stand-alone risks (just like the Lisbon Treaty defined Portugal as a stand-alone risk). If Greece issued a bond guaranteed jointly and severally by all EZ-countries, it would be akin to the Fed's buying treasuries (more or less).

      The Eurozone is a state which doesn't exist as such and it has a Central Bank which doesn't have a sovereign.

      Here is what I meant.

      Basel-2 introduced the new policy of making 'risk-weighted assets' the basis for equity requirements (before Basel-2, it was just assets). The banks do their own risk-weighting (thus they can manipulate the quality of their portfolio). It is common that different banks weight the same risk in different ways.

      Thus, Basel-2 said that everything that must not be risk-weighted is risk-free. Risk-free assets require no equity at all; thus, a bank could theoretically grow ad infinitum while have satisfactory equity ratios (as long as the growth was in risk-free assets).

      Lending to risk-free borrowers was more profitable (no equity required) than lending to risk-weighted borrowers (equity required). So banks ran up their portolios of risk-free assets. Deutsche, for excample, has 5 times as many risk-free assets as risk-weigthed assets.

      In short, Basel-2 incentivated the banks to grow without limits. Deutsche, which has very satisfactory equity ratios according to Basel-2, now has a leverage (equity over total assets) of about 40:1. Such a leverage would be considered as very high even for a hedge fund.

      Put differently, Deutsche finances only a little over 2% with equity. Basel-3 attempts to put a lid on that by introducing a minimum equity/assets ratio of 3%. One would say 'that's nothing'. Well, that depends. Deutsche has just announced 20% asset reduction program. Sounds sensational. But all it does is that it will bring Deutsche's equity/assets ratio slightly over 3%, and they need 2 years for that!

      What I meant is that Basel-2 essentially incentivated banks to limitless lending and since limitless lending was more profitable than limited lending, the results do not surprise.

      Basel-2 essentially said: limitless lending is not bad when it is risk-free. Well, first of all, what is risk-free in the world? US treasuries can be considered as risk-free because they are in USD and the borrower can print those. None of the EZ-countries can print the Euro. And, secondly, credit risk is not the only risk a bank has. It also has the funding risk and the larger the bank gets, the greater that risk becomes.

      To me, it is inexplicable how competent bank supervisors could construct such a self-goal which Basel-2 was (and with only a 3% ratio, Basel-3 is not much better).

    2. Your reply Klaus merely shows that this is a design flaw of the eurozone's structure.Sure there is no sovereign for the ECB but were the national governments treated as sovereigns then a) government bonds would remain credit risk-free just like anywhere else in the world, b) banks wouldn't have come under such stress.

    3. Maybe I didn't explain correctly. The only sovereign bonds which can/could be considered as risk-free are bonds issued by sovereigns in a currency which the sovereign can print. Such as US bonds of the US or sterling bonds of the UK. Nothing is totally risk-free because a government could default even on such a bond or force the citizens to roll them over (Germany with the Reichsmark during the war).

      Financial sovereignty means that you can print your currency. If you can think of a EZ-design which would have allowed countries to print their own Euros, please let me know.

      Eurobonds are the only answer to what you are trying to achieve.

      The banks' stress is indeed credit risk on one hand. On the other hand, banks have the funding risk. Banks typically fail as an immediate result of the funding risk. Short-term, the liability side of a bank is more important than the asset side. The larger a bank gets, the more exposed it is on the liability side.

    4. Your definition of financial sovereignty is one that I agree with.
      Still I insist, your correct observations simply show that it is the way the ECB treats gvt. bonds that makes the difference.Because all of the countries could have the same levels of debt and be perfectly solvent if the ECB wanted to maintain stability in the gvt securities market (Japan is a perfect example).

      A design where EZ countries could print euros would be pretty difficult but the ECB along with the primary dealers could make up for this difficulty.In the US the primary dealers usually cover as much as twice the size of the bond issuance.

    5. Can you explain this a bit more in detail?

      If a EZ-country can't sell its bonds at a reasonable price because there are no end-investors, I am not sure what a primary dealer can do about it. Of course, the ECB could buy them but then you are back in the discussion of the ECBs buying bonds to finance states.

      As far as I know, Japan works despite the massive debt because most of its debt is held domestically. To a Japanese saver, a Yen-bond of the state might be better than a CD with a shaky bank.

    6. Well the primary dealers are by nature meant to create markets for government securities.Primarily at the primary market but they also participate at the 2ndary market.
      This means that even if no non-primary dealer entities participate in an auction, the primary dealers will cover the whole auction by themselves and then look to trade the securities at the 2ndary market.

      With this solved there's only one obstacle with the ECB namely whether it would or would not try to affect the bonds' yield curve.Since this is precisely what happens with any other country I don't see why the ECB could not do it or what the objections could be.

      As for Japan, from the Japanese government point of view, it makes no difference whether the bonds are domestically held or foreign.It still has to repay the same amount of Yen.On the other hand, from the bondholders point of view, as you rightly say "To a Japanese saver, a Yen-bond of the state might be better than a CD with a shaky bank." which is true.But the reason why this happens is because there exists a highly liquid market for gvt. securities and then you even have the CB as a buyer of last resort.If those 2 parameters didn't exist they would invest on foreign bonds or other types of domestic assets that would literally be safer.

    7. That's how I understood the primary dealers to operate. I still don't understand how this would/should have worked in the EZ. Who would have been the primary dealers? Primary dealers auction the treasures in the hope that their bid to the Treasury is better than what they can subsequently ask from the secondary market. Sometimes they may be off. But with treasuries, we are talking about market movements of individual BASIS POINTS (if at all).

      It is understood that the ECB cannot buy primary issues (its mandate). Only in the secondary market and that, too, is being questioned by the GCC.

      Suppose Italy yields 7% and the ECB wants to bring it down to 2%. They would have to buy and buy and buy in the secondary market. But who would buy a new issue of Italy at 2% when the ECB can't? Here we are not talking about basis points!

      I look forward to your answer.

    8. " Who would have been the primary dealers?"
      The primary dealers already exist in the eurozone.For example even Deutche Bank that you mentioned above, is a primary dealer for Greek Bonds along with other foreign and Greek banks.You can see the list of the current PMs here

      "Primary dealers auction the treasures in the hope that their bid to the Treasury is better than what they can subsequently ask from the secondary market. Sometimes they may be off. But with treasuries, we are talking about market movements of individual BASIS POINTS (if at all)."

      It's not really clear to me what is your point with this paragraph.Please elaborate.However if you are implying that profit through arbitrage is the only reason why a credit institution becomes a PM then that's not totally correct.There are other advantages that other non-PM credit institutions do not enjoy e.g.

      Primary Dealers are granted:
      a. The exclusive right to submit before the auction one non-competitive bid pursuant to
      Article 16.1.
      b. The exclusive right to submit after the auction one additional non-competitive bid
      pursuant to Article 16.2.
      c. The right to participate in the supervising bodies engaging in ensuring the smooth
      operation of the securities markets, evaluating the degree of market organisation as well
      as the performance of Primary Dealers.
      d. Privileged access to information pertaining to the borrowing needs of the Hellenic
      Republic and issuance planning, new financial instruments and relating operating rules,
      securities in circulation, volume and turn-over as well as auction results.
      e. Exclusive access to short-term securities lending mechanisms that may be created
      (besides the automatic securities lending provided by the Bank Of Greece securities
      settlement System, hereinafter “BOGS”) in order to facilitate hedging (short selling).
      f. Privileged access to syndication pursuant to Article 14.
      9g. Privileged access to liabilities management. The Public Debt Management Agency shall
      take into account the credit rating of the counterparty with which it shall perform such
      2. The relations of Primary Dealers with the Bank of Greece as well as their activities within
      the framework of such relations are set by Bank of Greece Governor’s Acts.

      These advantages differ from country to country but you get the point.In some circumstances they are entitled to special lending conditions from the CB that other institutions don't enjoy.

      "Suppose Italy yields 7% and the ECB wants to bring it down to 2%. They would have to buy and buy and buy in the secondary market. But who would buy a new issue of Italy at 2% when the ECB can't? Here we are not talking about basis points!"

      Correct.Which leads back to my original argument.The problem lies with the way the ECB "treats" gvt. bonds.The fact that a country would be considered as solvent if the ECB acted as a buyer of last resort and this is not happening is really absurd to me, at a time where countries are going bust for this particular reason.Do you believe that if other CBs acted the same way as the ECB, we wouldn't have several insolvent states across the globe that are currently perfectly solvent?.
      If you agree that we would, then I would like to know what's wrong with the ECB doing the same or how the Eurozone is better off than them by not following the same direction.

    9. Even the greatest critics of the ECB agree that the ECBs mandate clearly prevents it from buying primary issues, i. e. where the money flows directly to the government. Now, that may be a lousy mandate but it's a mandate and it would take 27 countries to agree to change it. Monetary policy is not my cup of tea so I can only take your explanation at face value.

    10. But the ECB doesn't have to buy from primary issues.It just have to be the buyer of last resort from the secondary market i.e. buy from primary dealers who will have previously bought the primary issues!

      Also keep in mind that although it theoretically should have to buy all bonds outstanding as a buyer of last resort, it actually wouldn't have to.As long as the "markets" were assured that they would be able to get rid of the bonds at any time, the treasury market would automatically become more liquid and yields would drop to the ECB policy rate + premium reflecting inflationary expectations.That's the norm in the rest of the world and that was the norm before the euro for the eurozone countries.

  9. Change always comes from within. Although the handling of the crisis by the EU was terrible, it was the inability of the Greek politics to pass reforms which marked the whole issue as not possible. Even as we enter into the 3rd (or maybe 4th?) year of the Greek problem it appears that holes in public economics have not disappeared. Two days ago, the IMF reported an $11 billion hole in Greece's economics; the South America representative protested wildly against throwing more money into what has now become a bottomless pit.

    I may come off as mean or disrespectful but this is not my intention. I believe that unless the Greeks decide that they need to do this in order to progress then it this depression may last forever. It is not just political will. It is also the peoples' ability to comprehend and accept the situation, as well as the enforcing what needs to be enforced to make things work out. Mentality is the hardest thing to change and I am positive that you know this as well if you lived in Greece. Yet, whether we like it or not, it is that which needs to be changed for Greece to progress

    1. A year ago, I might have agreed with you. Today, I would say, as I said somewhere above: just wait until the French-German axis falls apart. Dahrendorf predicted the following in 1995:

      "The common currency project drills the countries to German behavior, but not all countries want to behave like Germans do. For Italy, periodic devaluations are much more useful than a fixed exchange rate and for France, higher government expenditures are more meaningful than a rigid adherence to stability criteria (which are, above all, an advantage for Germany).Yes, France and Italy go along with German demands if for no other reason than national pride. However, the price for that is very high and it could soon become apparent that it is too high - psychologically, politically and economically".

  10. "Neither is today's Euro suitable for the North because it makes it too easy for Germany & Co. to export (much of the exports are courtesy tax payers because tax payers lend the funds so that the periphery can pay for imports from Germany & Co. Put differently, a massive export subsidy!). If Germany & Co. were not in the Euro, they would have to become even more innovative and productive to remain competitive in the world and their surpluses would most likely come down."

    My problem with an analysis that includes this point is that there's no evidence for it. Germany's share of intra-EU trade has barely changed since the introduction the euro - which makes the idea that the euro constitutes some kind of massive export subsidy for Germany a slightly strange one.

    If the euro had that effect, we should expect to see a relative rise in the intra-EU trade shares of the northern countries, and a relative fall in the intra-EU trade shares of the southern countries - but no such change is observable. See:

    (PS. There is of course a way of countering my point without any fact-checking, which is to claim that in the absence of the euro, their trade share would have *fallen*, but I don't see any way of proving that to be the case, or any hope of claiming that the competitiveness of other EU countries has risen relative to Germany).

    1. Just add up the current account deficits from, say, 2010-12 of Greece, Spain and Portugal. Rest assured that those were financed by the ECB via Target-2 and, in a wider sense, that is tax payers' money. Put differently, if the ECB had not financed those deficits, there wouldn't have been current account deficits, those countries would have had to radically curtail their imports and, thus, the exports to those countries would have gone down (and, as a by-product, the Eurozone's payment system would have collapsed).

      You can also look at the Target-2 claims via-à-vis those countries. They are, of course, much, much larger because they not only include current account deficits but also capital flight.

      PS: Greece's current account deficit from 2010-12 was 29 BEUR.

    2. It simply isn't true and I don't know why you keep repeating this.

      The ECB didn't finance any current-account deficits, and it's refinancing operations certainly aren't taxpayer's money because, er, bank reserves aren't. We've been through this before.

      The ECB merely made sure that the payments system functioned because that is it's job, and because anything else would've meant the end of the monetary union.

      To say that the ECB financed the deficits of Greece would be like to say that the FED financed the loan of a US citizen because the citizen's bank used the FED's discount window. Well, that isn't so.

    3. Maybe you should join the discussion with Anonymous above who is trying his/her best to educate me on monetary policy.

      "The FED financed the loan of a US citizen because the citizen's bank used the FED's discount window" - have you seen the move ‘It’s a Wonderful Life’? There is a run on George Bailey’s S+L; the depositors think their money is stashed away at the bank and they want to have it back. And Bailey explains to them in which houses their money actually is. Someone is financing the assets of banks lending to US citizens. It may be depositors, interbank, bondholders – or the Central Bank if the bank has liabilities to the Central Bank.

      Money is a fungible entity; you can’t say where the individual deposit dollar goes. But the “sources & applications statement” in a financial report will tell you what all the sources were and what they were applied to.

      The ‘s+a statement’ of an economy’s cross-border transactions is the Balance of Payments. That tells you where all of Greece’s foreign money came from and what was done with it. In the last 3 years, almost all of Greece’s foreign money came from rescue loans and from the ECB (including Target2). The current account shows you part of what was done with it (including interest expense).

      The current account deficit must be financed by someone (just like deposit flight must be financed by someone if the banking system is to survive). To trace the financing of the budget deficit is easy because all you need to do is look at the books of one entity (the state). The current account deficit (and deposit flight) is spread throughout many entities, the entire national banking system.

      When a bank increases assets, it generally means disbursing funds (even if there is no actual disbursement). When the ECB runs up Target2, someone else runs up liabilities to the ECB. Target2 claims against Greece have an offsetting liability entry in the books of the Bank of Greece. And the liabilities of the BoG are offset by their claims against Greek banks which use that funding to finance the current account deficit and deposit flight.

      Yes, I agree that the ECBs job is to keep the payments system function, ALBEIT IT within its rules. The rules of the Fed are that their equivalent of Target2 claims must be settled once a year. The ECB doesn’t have such a rule. I agree with you that the Greek banks would have collapsed if the ECB had stopped funding (and the entire EZ payment system would have been severely damaged) but if you keep the payment system functioning, you also keep current accounts in existence. That’s my point and no more.

      I recognize that the ECB (or any other Central Bank) cannot go bankrupt. That’s why I said it is tax payers’ money in a ‘wider sense’. Technically, the ECB could run up a negative net worth ad infinitum without ceasing to function and without tax payers taking a hit. I am told that some Central Banks outside the EZ have a negative net worth. BUT: should the point ever come where the ECB transfers its losses to its owners, the national Central Banks, then it becomes tax payers’ money immediately because national Central Banks can go bankrupt. I. e. they would have to be recapitalized with tax payers’ money. I just think that it would be politically impossible for the EZ to allow the ECB to continue operations with a huge negative net worth.

      A satirist once said “the subprime market would have continued to operate swimmingly if no one had ever asked what those papers were really worth”. That’s a far-fetched comparison but to some extent it relates to what you are suggesting for the ECB to do.

    4. Well, Klaus, I don't agree with the way you present this because you are creating the impression (to people who are not familiar with monetary policy) that the ECB is giving money to Greeks in order to buy foreign products, whereas the truth is that the ECB (or in the case of ELA the Bank of Greece) is lending money to Greek banks so that they meet their reserve requirements.

      As for Target2, I don't think it's anything special at all, and the whole thing has been blown out of proportion. Again, this seems to terrorize people who are not familiar with reserve accounting but, well, they shouldn't be.

      In the end, one cannot escape the irritating thought that Europe rushed into monetary union, when it's blindingly obvious that it DOESN'T WANT TO BE in monetary union. That would've been fine, if there weren't real people and real lives at stake. As it is now, the mess is colossal.

    5. Jim, ping-pong is a lovely game and I hope that at least some readers follow our ping-pong and enjoy it! Trouble is: we are both just playing back-and-forth and no one is scoring... But it's probably better that way. Where would we all be if we always agreed on everything. There is no universal truth ("What is truth?" Pontius Pilatus asked the crowd...).

      Off the bat, we do have agreement on your last paragraph and that is progress! Now to Target2; again!

      Prior to the crisis, North/South Target-claims were more or less in balance. How was that possible when, say, Greece had a horrendous current account deficit in 2008 (15% of GDP!)? Who had financed those current account deficits then?

      It was private foreign banks which extended interbank financing to Greek banks. Beginning in 2008, foreign banks began to run down their interbank lending to Greece; Target-claims increased and private interbank claims declined.

      Suppose Deutsche had 1 BEUR interbank claims against Greek banks and decided to run them down. Deutsche's reduction was 'facilitated' (actually 'financed') through increased Target-claims on the part of the ECB. Thus, Deutsche's risk went to zero at the expense of the ECB.

      Actually, not only Deutsche profited from this change in lenders; the entire German financial system did! Before, Deutsche's Greek risk was 100% a risk of the German financial system. Afterwards, the risk to the German financial system was reduced to 27% or so, which is the percentage up to which Germany is liable for the ECB. Actually, not a bad deal for the German financial system!

      So, Target-claims against Greece increased in 3 stages: (1) replacement of private interbank loans; (2) continued current account needs; and the really big jump came through (3) capital flight.

      A Target type of system is not at all unique to the EZ. I already referred to the US. But let's go back to the Nazis. They had a very clever system where they used the deposits of occupied countries to finance all the things they had to finance. One example: French citizens thereby paid for the expenses of French POWs in Germany! And much, much more of the type. They did this through (a) forced loans (like the Greek one) and through (b) their equivalent of Target2.

      After the collapse, the occupied countries had enormous "Target-claims" against Germany (Greece, too). They either went up in smoke because of the collapse of the Reichsmark or they were forgiven by the creditors (under the strong influence of the US). But the system was more or less the same.

      This was my volley. Not it's your turn to return it...

      PS: money is a fungible entity. You can never specifically say that a bank uses a specific funding for this or that. One has to look at the aggregates of each application of funds. As a depositor, I could say that I finance a desk in the bank with my money; or a loan. That is not traceable. What is traceable, though, is the aggregate of deposits in relation to other funding.

    6. Aha. So let's assume that (before the crisis) Greek banks found the Greek private sector solvent enough to be given loans to, and lets' also assume that foreign banks did not finance the reserve requirements of Greek banks. We also know that because Greece run a current-account deficit, there was already a reserve drain taking place, which put upwards pressure on the interest rates of the Greek banking system.

      So, what would've happened? Simple, the reserve requirements would've been covered by the central bank (i.e. Target2), as long as they were in accordance with it's monetary policy (i.e. the interest rate it would want to achieve).

      Where I'm getting with this is that the interest rates set by the ECB were too low for Greece, which is why they caused this tremendous increase in the money supply and nobody objected at the time.

      In the end, one has to see the whole picture (i.e. on a European level) and conclude that the increase in the money supply in the North served the Eurozone economy as a whole because anti-demand policies in the South rendered monetary policy there ineffective.

      If the imbalances are deemed to be problematic, then you have to reverse the capital and trade flows, something which requires an awful lot of interventionism, plus acceptance for drastic changes in chronic attitudes. The chosen policy (austerity during a recession) reduces the money supply, something which hurts the Eurozone economy as a whole and deems monetary policy incapable of transmitting through the whole of the Eurozone (i.e. fragmentation of the Euro).

      My conclusion is that even though the Eurozone is a monetary union, it is still behaving as though it is on individual currencies!!

    7. "Where I'm getting with this is that the interest rates set by the ECB were too low for Greece, which is why they caused this tremendous increase in the money supply and nobody objected at the time".

      Spot on! But it is unrelated to what I said. What I said is, in simple terms, that there was a change of lenders. First, the lenders to the Greek banking system were private foreign banks, financing everything which the Greek banking sector needed (for current account deficits, for whatever). Then the private foreign lenders not only stopped lending; instead, they called their outstanding loans back. Someone had to fill this hole and that 'someone' was (and had to be in a monetary union) the ECB. That's all.

  11. I do not think that splitting the euro zone in a southern and northern euro will help, because it lives from the false assumption, that the difference between the southern and northern countries is the source of the problem.

    But the problem is, that the Euro does not allow any difference between countries due to its faulty design. The same problems we face today will show up sooner or later in the northern eurozone (or southern) too, because even here the countries are different. The only way to overcome the differences which build up with the time with a currency like the euro is deflation, which means lowering payments and increasing unemployment.

    In the euro zone we only have democracies. How will you tell the people, that they now will earn less money and 20% or more will even loose their jobs, because you saved the banks and the rich and ask them to vote for you in the same speech?

    So even leadership would not help since it will kill the leaders, in the worst case literally as seen in the 1930s.