Weekend Economists Sit on a Wall August 23-25, 2013

[Demeter]

27. To End the Eurozone Crisis, Bury the Debt Forever

http://www.nakedcapitalism.com/2013/08/to-end-the-eurozone-crisis-bury-the-debt-forever.html?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+NakedCapitalism+%28naked+capitalism%29

YVES...recovery is due to government spending, aka rising debt levels in the periphery. And that is where the VoxEu post below comes in. Pierre Pâris and Charles Wyplosz describe how the underlying European debt problems has merely been papered over and if anything has been getting worse, as the nexus between government debt and bank debt has increased. Mind you, this isn’t news per se, but somehow this underlying condition has been brushed aside as some of the vital signs of the Eurozone are looking better.

The article works through the options for resolving the situation and demonstrates the two that policy-makers have seized upon, austerity and asset sales, simply won’t succeed, and then discusses of the remaining, less politically palatable but economically tenable alternatives, which might work.

Mind you, Eurozone leaders have managed to patch things up and fend off crisis for years. Even now, we have some signs that things might be getting better, so that saying “this course of action will fail and more radical measures have to take place” seems a bit like crying wolf. But it is very hard to anticipate what will happen in Europe. Despite the appearance of improvement, the pressures are continuing to build. As I indicated earlier, some colleagues who visited several countries earlier this summer and met with well-placed economists and former officials said they thought the seismic shifts were less likely to be economic and the breakdown was more likely to take place in the political realm. What that will mean in practice is even harder to foresee than economic trajectories, and economists, despite their fondness for forecasting, are known not to have very good crystal balls.

Note that the article does come up with a fix which requires the ECB to balloon its balance sheet by 50%. That may or may not fly. But then it perversely argues that this situation should not be allowed to happen again, and points its finger at the lack of fiscal rectitude. In fact, except for known problem children (Greece, with its broken tax collection system) the blowout in government deficits in Europe was the direct result of the financial crisis, as tax revenues collapsed, unemployment and safety net payments rose, and governments stumped up to rescue bust banks. Thus the “never again” efforts should be directed first and foremost at making sure the banks don’t blow up the global economy for fun and profit.

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By Pierre Pâris, Banque Pâris Bertrand Sturdza SA, and Charles Wyplosz, Professor of International Economics, Graduate Institute, Geneva. Cross posted from VoxEU

The Eurozone’s debt crisis is getting worse despite appearances to the contrary.

Eurozone bond rate spreads have narrowed – leading some to think that the crisis is fading.1 Yet the narrowing is not due to an improvement in fundamentals. It happened after the ECB announced its Outright Monetary Transactions (OMT) programme. Mario Draghi’s, “Whatever it takes”, did the trick; investors believe the ECB could and would counter rising spreads in the medium term.2

But this means that the information in the spreads is muddled:

• Spreads no longer show us what investors think about debt sustainability.
• They reflect a mix of debt-sustainability expectations and forecasts of ECB reactions.

This is yet another instance of Goodhart’s Law – a variable that becomes a policy target soon loses its reliability as an objective indicator (Goodhart 1975).

How to Gauge the Eurozone Debt Crisis

This leaves us with a coarser measure – the evolution of public debts – as a ratio to GDP. Spreads were clearly better indicators before OMT. There are plenty of problems with debt-to-GDP ratios:

• Gross debts are gross, i.e. they ignore public assets.
• Gross debts ignore unfunded public liabilities such as pensions and healthcare.

In most countries the unfunded liabilities – which include the potential costs of bailing out banks when and if they fail – are vastly bigger than the public assets that can be disposed of.

• GDP is a static measure of the ability to pay; GDP growth also matters.3

Noting that Eurozone growth seems to have slipped into a go-slow phase, the GDP denominator is likely to grow slower than it did in the 1990s.

The three points taken together suggest that debt-to-GDP ratios of the 2010s paint a more optimistic picture of sustainability than the same levels in the 1990s.

SO MUCH MORE AT LINK...INCLUDING FEASIBLE SOLUTIONS THAT TPTB WILL NOT WANT TO LISTEN TO...