Richard Baldwin on ‘Phrase 2 of the Eurozone (EZ) crisis’

September 14, 2011

An excellent article by Richard Baldwin at from 5 September provides a great overview of the linkage between the various crises gripping the eurozone (EZ) and how we may be entering (or are already in) the next phase of these series of crises. Baldwin illustrates their interconnectivity with a simple diagram which PIIGSty has tidied up for clarity.

The connectivity is as follows:

(A) Lehman Vortex

  • Banks rely on investor and consumer confidence. Without confidence, investors and consumers withdraw their funds and the bank becomes insolvent (unable to fund its day to day operations).
  • When Lehman collapsed on September 15, 2008 – a plague spread rapidly through Wall Street as fast moving investor capital began to flood from (up to then) other steady investment banks
  • This is a self fulfilling prophecy – if investors/consumers believe their bank is about to go bust and their cash to disappear, they will rush to (or ‘run on’) the bank and withdraw. Similarly, interbank lending (banks lending to each other) is likely to completely shut down. Banks can’t access funding – so who do they borrow from?
  • This means that just the fear of solvency freezes long term funding making banks insolvent.

(B) Sovereign & Implicit TBTF ‘Irish’ Vortex

  • Large bank failures and their threatened insolvency, due to their integrated nature of national economies (the body) and banking credit (the blood that circulates) – mean that insolvent banks can cause sovereign insolvency. This requires, as in Irish case, direct funding from the exchequer funded by sovereign debt.
  • The opposite is also true of the PIIGS-Northern European bank relationship – where banks hold PIIGS national debt meaning sovereign insolvency (in the periphery) can cause bank solvency (which causes a cyclical effect and the process repeats). This why ‘burning the bondholders’ in Portugal/ Ireland/Greece really means scorching Northern European commercial banks in Germany, France, Belgium, the Netherlands and others – a potential destabilising factor for otherwise stable economies.

(C) Austerity-Trap Vortex

  • If a nation tries ‘too little too late’ Greek style reactionary austerity policies, it can get caught in an ‘auserity trap’ where stringent cuts lower income levels, depressing tax revenue, raising spending on welfare and ultimately making increased borrowing necessaryworsening deficit/debt levels

(D) Debt Service Vortex

  • Nations spending becomes orientated not toward their taxpayers but toward paying debt levels of a past generation, contributing a significant proportion to exchequer spending.

To end the cycle, the options are pretty sparse, and both are debt laden, politically painful options for the richer EZ members (and aren’t particularly short term solutions either)

  1. Adopt credit debt smashing domestic institutions  i.e. adopt a stringent line on debt
  2. Gift national fiscal policy to a higher coordinated authority via fiscal union


The bottom line? So long as economies are in recession, these 4 branches/vortexes of the current EZ crisis will continue. Yet we still live in uncertain times with daily warnings of a return to negative growth and the spectre of a double dip recession in many economies. Recessionary fears stoke these 4 branches, injecting uncertainty back into the system in a painful cyclical repetitive process that European leaders seem content to oversee as hand wringing spectators. That is what caused Italy and Spain, as well as French banks and others to head south recently before stabilising again.

When European leaders meet, the panic subsides. Echoing Mr. Baldwin, PIIGSty firmly hopes “[that European leaders] actually get up and put the crisis to bed, rather than hitting the snooze button and heading back to bed themselves.’ Who knows! Maybe the markets are pushing the leaders into action. Lets hope it doesn’t require a real scare.



UBS Economists on the € (Echos!)

September 9, 2011

In the PIIGSty Publication on the euro, we said there are fundamental aspects to the single currency which make its collapse or break-up next to impossible. Looks like we’re not alone in that (learned) opinion! Economists at UBS have totted up the sums on the cost of a country withdrawing from the euro. It doesn’t show a pretty picture.

Heres the PDF

Their main finding: “the Euro (as currently constituted) should not exist.”

The basic summary of their findings are as follows:

  • The euro isn’t working so either its operation or its membership must change
  • Most likely scenario: the eurozone (EZ-17) moves “painfully” toward fiscal integration

Economic Costs

  • Consequences of  a weaker country (PIIGS) leaving the euro are immense (40-50% of GDP in year 1). This includes the cost of sovereign and corporate defaults and a collapse of national banking and trade.
  • Consequences of a stronger country (Germany) leaving the euro are still immense (20-25% of GDP in year 1). Germany would avoid sovereign default and collapse of their banking system but would incur costs related to corporate default and trade decline.
  • Cheapest option? Bail out the ‘PIG’ nations (single hit of around 5.5% of GDP)

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Fortune Magazine’s take on Europe

August 19, 2011

Fortune Magazine’s Shawn Tully has a stab at analysing the eurozone/European crisis. Its nothing we haven’t covered before at but heres the summary:

  • Greece is a mess. The climate for business is extremely weak
  • Theres two problems feeding into the stock market volatility (a) Fear of contagion in Europe (2) S&P downgrade of US sovereign debt (reflective of a polarised political environment in the US Congress)
  • Rumours suggest that French banks (big owners of Italian and Spanish bonds) might be struggling to stay liquid
  • European credit crunch is happening (European banks are worried and reluctant to lend, slowing EU growth) – this could kill a US recovery (EU accounts for 21% of US exports)
  • If 1 country leaves the euro, then domino effect likely causes gigantic defaults and an EU banking crash

Story of the euro

See the PIIGSty Publication on the euro – but FYI its like this…

  • Launched in 1999 aiming to bring Europe closer together (in terms of productivity and growth) and make the eurozone the equal of Asia or the US
  • Didn’t work – some took advantage of imported low interest rates (via leapfrogging on German credibility) with rates falling from 15% to the German level of around 5%. PIIGS boomed!
  • These countries (Italy, Spain, Greece are mentioned) didn’t allow productivity levels to improve – they binged on cheap credit – continued support for cartels, anti-competitive practices and centralised wage bargaining.
  • Example of Greece: Money didn’t go to improve the capacity of the economy – it went on discretionary/consumer spending – meaning higher wages. Greece became expensive for tourists.
  • ECB now has to buy Spanish/Italian bonds to ease the pressure on the now debt laden countries from falling victim to contagion from Greece

Two things need to happen…

  1. Austerity-  the PIIGS need to close their deficit gaps
  2. Modernisation and Growth – PIIGS need to grow (to pay the debt) via modernisation/privatisation plans AND belated open their markets

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Michael Lewis on Germany

August 10, 2011

Michael Lewis of Vanity Fair is no stranger to Europe.

  • In April 2009, Lewis published ‘Wall Street on the Tundra an article tracing the logic behind the economic meltdown in Iceland.
  • In October 2010, Lewis followed this up with a study into Greece in an article entitled ‘Beware of Greeks Bearing Bonds.’
  • In March 2011 Lewis made waves in Irish political circles (an article published in the March edition of VF but available during the final calamitous days of the Cowen government) with his devastating insight into the banking and political upheavals in Ireland with his ‘When Irish Eyes are Crying.’

In the September 2011 issue of VF, Lewis has focused on Germany – EU lender of last resort and lynchpin of the euro – in an article entitledIt’s the Economy, Dummkopf!’

Heres your summary…

Lewis begins with a valuable insight into the German character – something with has an historical affiliation with…well….’faecal matter.’ From bizarre childhood folklore tales and Gutenberg’s strange choice for his 2nd printing to Martin Luther’s ‘scatological’ original idioms and Hitler sexual desires–a key German character trait is an obsession with waste or at least, taking dirt and cleanliness in equal measure – an affliction deeply ingrained but hidden within.

The article pivots into more analytical territory with a reference to sobering and contrasting statistics. Greece unemployment at 16.2% versus a 20-year low German rate of 6.9%. A job in Germany which pays €55,000 pa, pays €70,000 in Greece – effectively two extra monthly payments. Greece is plaqued by debt and deficits – with the euro like a inverse gastric band meaning the binge cannot stop. Greece, according to Germans, have two choices. Slim down government (and sacrifice growth) and fiscally integrate into Europe or reform how Greeks work and make the Greek people…Germans…with all the efficiency and productivity that goes along with that stereotype. Economically, the only solution is for German to stop bitching, arguing and hoping and just write the cheque. Politically, this isn’t a runner for Merkel. So, Europe trundles on, with regular crises (as in Spain and Italy recently and soon in Cyprus and France) meaning stop gap sticking plaster solutions that solve nothing.

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Life in the Eurozone: With or Without Sovereign Default

July 31, 2011

On 14 April 2011 the European University Institute in Florence, Italy (A stunning university might I add …) organised a conference entitled “Life in the Eurozone: With or Without Sovereign Default”. With valuable contributions from several esteemed guest speakers from across the EU, their presentations were published in a book of the same name which can be found at:

Invaluable, yes. Brief, no…but is it 180 odd pages of extremely useful insights.

I’ve summarised their findings in 15 pages pictorally for you to read, study, pin up on your wall, photocopy, claim credit for…whatever…

I honestly don’t mind (just send me a decent Christmas card)

PIIGSty Summary: Life in the Eurozone