City wire montreux may 2012 on eurozone crisis

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  • 1. Where does the Eurozone Crisis go from here? Presentation to CityWire event, Montreux 9 May 2012 Andrew Lilicowww.europe-economics.com
  • 2. Overview• Austerity plus limited debt pooling will fail => break-up of € – But austerity is not undeliverable everywhere• Full debt pooling will fail => break-up of € – Eurobonds etc. would be even worse than austerity alone• Disorderly break-up of € would be disastrous• Euro doesn’t need to collapse, just lose a couple of members (and it probably will)www.europe-economics.com
  • 3. The Eurozone Crisis: Different crises in different countries2010 figures Govt debt to Govt deficit Bank assets Avg Growth(Eurostat) GDP to GDP 2000-2010“Unsalvageable”Greece 143% 11% 173% 2.4%Cyprus 61% 5% 586% 2.8%“Banking crisis”Belgium 97% 4% 182% 1.4%Spain 60% 9% 335% 2.1%Ireland 96% 32% 328% 2.4%“Competitiveness Crisis”Italy 119% 5% 163% 0.2%Portugal 93% 9% 240% 0.7% www.europe-economics.com
  • 4. Austerity Plans are Large in Scalewww.europe-economics.com
  • 5. Program Change in tax Change in public Change in fiscal Change in expenditures revenues as % expenditure as % balance as % of peak to trough as % of total of GDP of GDP GDP expenditure in peak year1920s UK -1.9% -5.6% 3.7% -11.4%1930s UK -0.1% -3.7% 3.6% -5.8%1960s UK 3.7% -2.0% 5.7% -0.4%1970s UK -2.2% -5.1% 2.9% -4.0%1980s UK -4.9% -9.2% 4.3% -3.3%1990s UK 3.2% -6.3% 9.5% -2.8%1990s Sweden 7.0% -7.8% 14.8% -3.1%1990s Finland 5.3% -6.7% 12.0% -2.0%1990s Canada 3.7% -5.8% 9.5% -4.3%1990s Ireland -3.7% -14.3% 10.6% -8.7%1990s Germany 0.7% -3.9% 4.6% -3.1%1990s Neth -2.5% -3.9% 1.4% -0.7%Portugal 0.8% -6.7% 7.4% -13.2%Ireland 0.7% -5.8% 6.6% -5.6%Italy 1.4% -2.8% 4.2% -1.3%Greece 1.2% -11.6% 12.7% -23.6%Spain 2.4% -4.7% 7.1% -5.7%Belgium 0.8% -1.8% 2.6% No fallFrance 1.9% -4.3% 6.2% No fall www.europe-economics.comAustria -0.8% -2.8% 2.0% No fallUK 2010s 1.1% -8.1% 8.6% -5.5%
  • 6. Austerity Plans are Long in Duration Number of Number of Number of Number of years years years years spending spending spending to spending was cut until remained be cut until to remain trough less than trough less than peak year peak year1920s UK 3 6 Portugal 3 >61930s UK 2 4 Ireland 3 >51960s UK 1 1 Italy 3 61970s UK 2 4 Greece 5 >71980s UK 4 6 Spain 3 >71990s UK 2 4 Belgium 0 No fallSweden 2 3 France 0 No fallFinland 1 3 Austria 0 No fallCanada 2 2 Memo UK 5 >6Ireland 2 3 2010sGermany 1 1Netherlands 1 1 www.europe-economics.com
  • 7. Austerity Plans are to be Implemented without an External Depreciationwww.europe-economics.com
  • 8. Belgium (1982-97) Greece (1981-97)400 4 400 4300 3 300 3200 2 200 2100 1 100 1 0 0 0 0-100 -1 -100 -1-200 -2 -200 -2-300 -3 -300 -3-400 -4 -400 -4 Spain (1981-97) Ireland (1981-97)400 4 6000 4300 3 3 4000200 2 2 2000100 1 1 0 0 0 0-100 -1 -1 -2000-200 -2 -2 -4000-300 -3 -3-400 -4 -6000 -4 Portugal (1986-97) Italy (1988-97)400 4 400 4300 3 300 3200 2 200 2100 1 100 1 0 0 0 0 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997-100 -1 -100 -1-200 -2 -200 -2-300 -3 -300 -3 www.europe-economics.com-400 -4 -400 -4 Change in fiscal balance (% of GDP) Change in exchange rate vs DM relative to underlying change 1981-2003
  • 9. Debt Dynamics are Challenging Greece Portugal Ireland Spain Italy Belgium 2011 Debt / GDP 140% 102% 108% 70% 121% 97% Average inflation 4% 4% 2% 2% 2% 2% Average GDP growthModel Assumptions 2012-15 -1.3% 0.2% 2.0% 1.0% 1.0% 1.7% Average GDP growth 2015 on 4.0% 2.0% 2.5% 2.5% 1.75% 2.0% Yield on new debt 10% 8% 6% 6% 6% 6% Average debt maturity 7 5 6 6 7 6 Primary surplus (% of GDP) 6.8% 3.0% 4.0% 2.0% 5.0% 3.0% Debt to GDP (2020) 120% 99% 87% 65% 99% 87% www.europe-economics.com
  • 10. Some, but not all, Fiscal Programmes are Implausible • Do-able: – Italy, Ireland (2010s programmes no tougher than delivered 1990s programmes) • Not do-able: – Greece, Portugal (too big, too long) • Intermediate: – Spain (just about doable if nothing goes wrong, but vulnerable to events)www.europe-economics.com
  • 11. Could EU Instruction Make the Difference?Country Year of most Year of Years Country Year of Year of Years recent Acc- demo- most recent Acc- democratic introduction ession cratic intro- ession outside of to EEC outside duction of to EEC EU/EEC democracy* EU/EEC democracy*PIIGS Estonia 1991 2004 13Greece 1974 1981 7 Finland 1906 1995 89Ireland 1832[?]/1922 1973 141[?]/51 France 1944 1952 8Italy 1948 1952 4 Germany 1949 1952 3Portugal 1975 1986 11 Hungary 1990 2004 14Spain 1978 1986 8 Latvia 1990 2004 14Others Lithuania 1992 2004 12Austria 1945/1955 1995 40/50 Luxembourg 1945 1952 7Belgium 1944 1952 8 Malta 1964 2004 40Bulgaria 1991[?] 2007 16[?] Netherlands 1945 1952 7Cyprus 1974 2004 30 Poland 1989 2004 15Czech 1989/1993 2004 15 Romania 1990 2007 17Republic Slovakia 1998 2004 6Denmark 1945 1973 38 Slovenia 1990 2004 14 www.europe-economics.com Sweden 1907 [?] 1995 88 [?] UK 1832 [?] 1973 141[?]
  • 12. Real Unit Labour Costs150140 Greece Italy130 Portugal Spain120 Ireland France110 Belgium Austria100 Germany 90 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 www.europe-economics.com
  • 13. Degrees of Internal Devaluation Still Required 35Percentage internal devaluation to 30 reach Germaan RULC levels Peak 25 2011 20 15 Likely threshold of sustainability 10 5 0 Greece Ireland Italy Portugal Spainwww.europe-economics.com
  • 14. OK – What About Debt Pooling? • Problems are: – Cost to France & Germany – Lost Growth for France & Germany – Absent conditionality, result would be debt more than 30% higher – Conditionality => Reduction of receivers to economic vassals • Will not be sustainablewww.europe-economics.com
  • 15. Scale – Total Requirement Greece Portugal Ireland Italy Spain eurobonds eurobonds total current requirement Budget Budget Budget Budget Budget requirement (€m) surplus (€m) surplus (€m) surplus (€m) surplus (€m) surplus (€m) (€m)2012 -14,922 -7,658 -13,842 -38,181 -57,600 441,865 574,0682013 -11,402 -5,259 -11,374 -19,036 -50,700 259,185 356,9562014 -6,344 -4,254 -7,736 -18,477 -48,600 212,757 298,1682015 -6,596 -3,618 -7,540 -19,862 -50,600 174,104 262,3202016 -6,753 -3,299 -7,209 -20,765 -52,500 122,258 212,784 Total 1,704,296 www.europe-economics.com
  • 16. Burden of Eurobonds to Donors Luxem- Germany Austria Netherlands Finland France Total bourg2012 257,290 30,589 61,190 19,799 4,586 200,614 574,0682013 158,777 19,199 38,043 12,497 2,873 125,568 356,9562014 131,661 16,147 31,768 10,543 2,420 105,630 298,1682015 114,796 14,289 27,990 9,371 2,148 93,728 262,3202016 92,231 11,640 22,716 7,674 1,762 76,759 212,784Total 754,754 91,867 181,704 59,886 13,789 602,296 1,704,2962010 Public Debt 2,100,000 205,000 370,000 90,000 8,000 1,600,000Addntl “virtual” debt 36% 45% 49% 67% 172% 38%as % of 2010 level“Virtual” Debt / GDP 114% 104% 94% 82% 53% 114%incl addtnl burdenRating downgrade 2 2 1 0 0 2(notches)Addtnl debt serv 100bps 100bps 50bps 0 0 100bpsburden (bps)Addtnl annual debt €21bn www.europe-economics.com €2bn €1.9bn 0 0 €16bnserv burden (€bn)
  • 17. Growth implications of Eurobonds • Italy: PLUS 0.3-0.4% per year • France, Germany: MINUS 0.2-0.3% per year • Austria: MINUS 0.1-0.2% per year • Ireland, Spain, Netherlands, Finland, Luxembourg: Growth unaffectedwww.europe-economics.com
  • 18. Debt pooling, Conditionality and Vassaldom• Without conditionality: – In academic studies (Gneezy, Haruvy and Yafe, Economic Journal 2004), splitting the bill => 36% higher bill• With conditionality:www.europe-economics.com
  • 19. Implications of Disorderly Collapse – Massive disorderly capital flows – Multiple sovereign and private sector defaults – Sov. defaults+capital flight => banking sector collapses – Shortages of essential goods – Considerable social disorder • This could rapidly result in constitutional overthrows in multiple Member States. – The collapse of trade within the EU – In the event that there were a sovereign default by Italy, the collapse of much of the French, UK, and hence US banking sectorswww.europe-economics.com
  • 20. Italy is very unlikely to default within the euro • In early 1990s Italy – Had 10-year bond yields of 8-14% (vs <6 now) – Had debt to GDP 120% (= now) • Memo: Italian peak deficit: 5.4% (e.g. France 7.5%) – Did not inflate away debts (CPI was around 4% and falling in early 1990s) – Had real growth of just 1.3% per annum – Spent >11% of GDP on debt servicing – Did not default • Also, there is no euro without Italywww.europe-economics.com
  • 21. It is euro collapse that threatens Italian default, not other way around• Italy has only ever defaulted (briefly) in 1940 – Very good record at paying debts back a key reason why able to accumulate so much debt!• If euro were to collapse (e.g. Germany leaves) Italian default risk becomes high• Consequences v seriouswww.europe-economics.com
  • 22. Cross-border exposures Banks of… Austria Belgium Greece Portugal Spain Ireland Italy FranceExposure toHungary 26 11 0 0 1 0 16 4Greece 2 1 0 6 1 1 2 35Cyprus 2 0 8 0 0 0 1 2Portugal 1 2 0 0 57 1 3 19Spain 5 15 0 18 0 9 21 105Ireland 2 17 0 4 6 0 12 21Italy 16 16 0 2 26 8 0 270Tot of selectedcountries 52 63 9 30 91 19 55 456All internationalexposures 363 263 91 90 1043 247 645 2215Selected as % 14% 24% 10% 33% 9% 8% 9% 21% www.europe-economics.com
  • 23. Cross-border exposures as % of GDP Banks of… Austria Belgium Greece Portugal Spain Ireland Italy FranceExposure toHungary 9.4% 3.1% 0.1% 0.1% 0.1% 0.0% 1.1% 0.2%Greece 0.7% 0.3% 3.8% 0.1% 0.4% 0.2% 1.9%Cyprus 0.6% 0.1% 3.7% 0.1% 0.0% 0.0% 0.1% 0.1%Portugal 0.3% 0.7% 0.0% 5.6% 1.0% 0.2% 1.0%Spain 1.6% 4.5% 0.1% 10.7% 6.1% 1.4% 5.6%Ireland 0.6% 5.0% 0.2% 2.2% 0.6% 0.8% 1.1%Italy 5.6% 4.7% 0.2% 1.1% 2.5% 5.5% 14.5%Tot selectedcountries 18.8% 18.4% 4.2% 18.0% 8.9% 13.0% 3.7% 24.5%All int exp 131.7% 77.2% 42.0% 53.9% 101.9% 170.3% 43.3% 119.1% www.europe-economics.com
  • 24. Italian Default would Threaten France • French cross-border banking exposures to Italy at 14.5% of GDP even higher than – Portugal to Spain – Austria to Hungary • Tough to set out scenario in which Italy defaults but not France – Would rely on Germany standing behind France but not Italywww.europe-economics.com
  • 25. How to save the euro• Work backwards from solution to members – Can have euro without Greece but not without Italy• Three kinds of solutions: – Spain: “Don’t be Ireland” => debt-equity swaps for bank debt – Italy (+ Portugal?): Structural funds => growth – Greece, hence Cyprus (+ Portugal?): leave euro • Probably bad for Greece; Good for everyone else because can save Italywww.europe-economics.com
  • 26. Reject any form of debt pooling! • “Debt pooling” = any arrangement under which Germany, France, Finland, etc. become responsible for current Italian, Spanish etc. debts – “Eurobonds”; “leveraged EFSF”; “ECB purchases of €trs of PIIGS bonds” are all debt pooling • Fiscal union ≠ debt pooling – Collective debt issuance ≠ responsibility for legacy debtwww.europe-economics.com
  • 27. Solution for “banking crisis” countries• Disentangle state from banking sector• Banks distressed => impose debt-equity swaps – Bring forward EC “bail-in” proposals to now from 2013 • Part of more general special resolution regime for banks• Do not cast good money after bad (“recapitalisation”) – Not • an irrational market error • a “speculator attack” • simply insolvency from past losses – Banking bailouts • Immoral (tax the poor to spare rich the consequences of their errors) • Economically destructive (moral hazard; financial instability) • Failed strategy, even in own misguided terms www.europe-economics.com
  • 28. Solution for “competitiveness crisis”countries• Raise growth rate enough for countries to service own debts• How? Eurozone-only structural funds (“Eurozone competitiveness funds”) – Monies spent by Brussels (so no lobster problem) – Monies spent by Brussels (so no vassal problem) www.europe-economics.com
  • 29. Amounts required – Ireland in 1990s: 0.5% of GDP on structural funds – Italian + Portuguese GDP = €1.8tr => 0.5% = €9bn • Might need twice this level in early years to be credible • cf structural & cohesion funds budget = ~€58bn per year – Key: spend on investments => GDP growth effect, not just levels • Might need to rise over time, even with some growth effect• cf cost of debt pooling – Effectively taking German and French debt exposures to current Italian levels – add ~ 100bps to funding costs => ~€36bn per year www.europe-economics.com
  • 30. Curlicues• Real money, not “guarantees”• Initiative principle would be different – Structural funds match funding to govt projects• Match funding abandoned – Brussels initiative to spend => spending sovereignty centralised• Accompanied by tighter fiscal policy constraints – Probably any budget running a deficit above 2% of GDP to be approved by Brussels – => fiscal sovereignty centralisedwww.europe-economics.com
  • 31. Longer term• Funding for Eurozone competitiveness funds: – Initially fund with Eurozone member contributions – Later impose special Eurozone taxes – With a funding stream in place, could issue own debt • Call these “Eurobonds” if you like, but they aren’t debt pooling (no legacy debt)• Eurozone taxes + spending sovereignty, and curtailed Eurozone Member fiscal sovereignty => need for democratic mechs – Eurozone finance minister, perhaps directly elected? www.europe-economics.com