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Número 98

ANEXO III

Alvaro Espina 1 de Septiembre de 2013

ENTRE EL 21 DE JULIO DE 2013 Y EL 31 DE AGOSTO DE 2013

August 31, 2013, 4:10 pm 194 Comments The Arithmetic of Fantasy Fiscal Policy Sometimes — usually, though not always, in a belligerent tone — people ask me, well, how big do you think the stimulus should have been? How much debt should we have run up? Regardless of the tone, that is actually a question worth answering. With the benefit of hindsight, we do know roughly how depressed the economy has been; we have reasonably good estimates of the effects of government spending; so we can put together an estimate of what would have happened if we had, in fact, pursued a policy of government spending sufficient to keep output at potential. Start with the CBO estimates of potential GDP, which can be subtracted from actual GDP to estimate the output gap. Start the clock at the beginning of 2009, and the output gap — measured quarterly, but at an annual rate — looks like this:

The output gap. If you add it up, the cumulative output gap since start-2009 comes to $2.29 trillion — that is, $2.29 trillion worth of goods and services we could and should have produced, but didn’t. How much government spending would have been required to close that gap? The evidence is now overwhelming that when you’re at the zero lower bound the multiplier is greater than one; see,e.g., Blanchard and Leigh. Suppose we take a multiplier of 1.3, which is fairly conservative. Then it would have taken $1.76 trillion in spending over the past 4 1/2 years to close the output gap. Yes, I know, it would have been politically impossible — but we’re just doing the economics here. So is that an extra $1.76 trillion in debt? No — the economy would have been stronger, leading both to higher revenue and to lower spending on means-tested programs. A fairly conservative estimate is that each dollar of extra GDP would have saved 1/3 of a dollar in the form of higher revenue and lower spending, which means 2.29/3 = $0.76 trillion. So the net extra debt we would have run up with my fantasy stimulus turns out to be a round $1 trillion. OMG: ONE TRILLION DOLLARS! But how bad is that? It’s about 6 percent of GDP. And remember, also, that GDP would have been higher — it would have been at potential, not well below. So at this point, instead of where we are — with federal debt at 72 percent of GDP — we would have had federal debt at 76 percent of GDP. Does anyone seriously claim that this difference would have caused a fiscal crisis? And in return for those 4 points on the debt ratio, millions of American families would have been spared the hardship and humiliation of mass unemployment, lost houses and savings, and more. We can further argue that by avoiding the corrosive effects of long- term unemployment, we would surely have avoided substantial damage to America’s longer-run economic prospects, which in turn means that future revenue would be higher — and my fantasy fiscal program would probably have improved, not worsened, our fundamental fiscal position. Again, I understand that none of this was going to happen. But you should understand that this reflects bad judgment by bad politicians and bad economists, not the logic of the case. http://krugman.blogs.nytimes.com/2013/08/31/the-arithmetic-of-fantasy-fiscal-policy/

August 31, 2013, 11:50 am 101 Comments Bankers, Workers, Obama and Summers Brad DeLong has an excellent piece distinguishing between two views of central banking. There’s the “banking camp,” which sees the central bank’s job as being to secure the stability of the financial system – full stop. OK, maybe also price stability. And then there’s the “macroeconomics camp,” which sees the central bank’s job as being to achieve full employment; banking stability and even price stability are basically means towards that end. Brad complains that the Fed has ended up being much more in the banking camp than many macroeconomists would have wanted. See, for example, the harsh criticisms leveled at the Bank of Japan by one Ben Bernanke in 2000, criticisms that apply almost perfectly to the Bernanke Fed of today. But I think Brad casts his net too narrowly: it’s not just central bankers who fall into these two camps. And one important consequence of this division is an utterly different read on recent history. Ask yourself: How well did we respond to the crisis of 2008? If you’re in the banking camp, here’s what you see:

The financial system was in great danger – but catastrophe was averted. We’re heroes! On the other hand, if you’re in the macroeconomics camp, here’s what you see:

A catastrophic collapse in employment, with only a modest recovery even after all these years. (It looks a bit better if you adjust for an aging population, but not much). We blew it! Which brings us to what looks more and more like Obama’s decision to choose Larry Summers as Fed chair, passing over Janet Yellen. As of right now, Summers is clearly not in the banking camp; the stuff he has been writing about fiscal policy makes it clear that he very much believes that the job of economic recovery is not done. On that basis, you would expect him to prod the Fed into doing much more than it is. On the other hand, given Bernanke’s pre-Fed record you would have expected the same thing — maybe even more so, because Bernanke had strongly emphasized the central bank’s responsibility for economic growth. Once at

3 the Fed, however, Bernanke appears to have been assimilated by the Borg, moving much closer to the banking camp. Would the same thing happen to Summers? I worry. And one of the strong (though probably futile at this point) arguments for Yellen is that she spent years at the Fed without being assimilated, never losing sight of the crucial importance of employment. While Summers isn’t in the banking camp, however, Obama is. As Ezra Klein explains, his choice of Summers clearly reflects his view that policy in 2009-2010 was a great success, not a big disappointment, and he wants to keep the winning team together. Of course, it’s a lot easier for Obama to consider his policies a success given that he was reelected. Obviously I’m in the macroeconomics camp, not the banking camp, so this is all depressing, in several senses. It means, among other things, that even if Summers is the right choice — which we’ll never really know — it’s a choice that Obama is making for all the wrong reasons. http://krugman.blogs.nytimes.com/2013/08/31/bankers-workers-obama-and-summers/

August 30, 2013, 9:21 am 42 Comments The Baht and the Bubble Excuse

IMF Kevin O’Rourke has been saying for a while that it’s useful to think of Ireland as “Thailand without the baht“. In this context, the history of the Asian crisis sheds some light on one of the ways defenders of European austerity policies move the goalposts: by claiming that the pre-crisis peak isn’t relevant for comparison purposes, because it was inflated by a bubble. This excuse plays a central role in claims that Latvia is a big success story, and to a lesser extent in defenses of Ireland’s record. Often, although not always, it reflects a

4 confusion between demand and supply — saying that there was excess spending on, say, housing doesn’t mean that the economy couldn’t have been producing something else instead. (In fairness to the Latvian authorities, they aren’t falling into this fallacy; their claim is that the economy was seriously overheated and suffering inflation). In any case, Asia from 1997 on provides a useful comparison. Southeast Asia in the mid-90s was a bubble — oh, boy, was it a bubble, with huge current account deficits and wild speculation in real estate. Nonetheless, by contrast with Europe’s crisis economies, the Asians fairly quickly returned to and then passed the pre-crisis peak: I will say, 15 years ago it would never have occurred to me that we would be looking back at Asia’s crisis as a success story. http://krugman.blogs.nytimes.com/2013/08/30/the-baht-and-the-bubble-excuse/

FT Alphaville ft.com Comment Blogs > The portable Summers Joseph Cotterill Aug 30 11:30 3 comments Share The Fed is his to lose, so here’s a useful service by Barclays rates analysts — quotes from Larry Summers on monetary policy, all the way from December 1986 to August 2013, all in one place. Click to enlarge.

At the very least, we’ve been warned. http://ftalphaville.ft.com/2013/08/30/1619852/the-portable-summers/

Corporate Profits & What Siegel Is Missing Written by Lance Roberts | Friday, August 30, 2013 Recently I wrote a post titled "Earnings & Profits Per Share Discuss Overvaluation" which discussed that when looking at NIPA profits the deviation from their long term growth trend suggests overvaluation. Specifically I stated:

"As you will notice each time that corporate profits (CP/S) and earnings per share (EPS) were above their respective long term historical growth trends the financial markets have run into complications. The bottom two graphs shows the percentage deviations above and below the long term growth trends.

What is important to understand is that, despite rhetoric to the contrary, "record" earnings or profits are generally fleeting in nature. It is at these divergences from the long term growth trends where true buying and selling opportunities exist. Are we currently in another asset "bubble?" The answer is something that we will only know for sure in hindsight. However, from a fundamental standpoint, with valuations and profitability on a per share basis well above long term trends it certainly does not suggest that market returns going forward will continue to be as robust as those seen from the recessionary lows" The reason I discussed this particular metric was due to a recent article by Jeremy Siegel on market valuations based on corporate profits rather than Robert Shiller's cyclically adjusted P/E (CAPE) ratio. Siegel stated: "I believe the Cape ratio’s overly pessimistic predictions are based on biased earnings data. Changes in the accounting standards in the 1990s forced companies to charge large write-offs when assets they hold fall in price, but when assets rise in price they do not boost earnings unless the asset is sold. This change in earnings patterns is evident when comparing the cyclical behaviour of Standard and Poor’s earnings series with the after-tax profit series published in the National Income and Product Accounts (NIPA). For the 2001-02 and 2007-09 recessions, S&P reported earnings dropped precipitously due to a few companies with huge write-offs, while NIPA earnings were more stable. Yet before 2000, the cyclical behaviour of the two series was similar. Downward biased S&P earnings send average 10-year earnings down and bias the Cape ratio upward. In fact, when NIPA profits are substituted for S&P reported earnings in the Cape model, the current market shows no overvaluation." My point is that regardless of the metric that you use; deviations from the long term growth trend are unstainable and will eventually mean revert. Mebane Faber wrote an excellent piece in this regard noting that Siegel is likely missing the bigger picture. Faber noted: 1. He talks about write downs and how that biases CAPE. The problem is, even if you ignored the bear market, even if the earnings decline of 2008,2009, 2010 never happened, effect on PE10 / CAPE would be mild- it would go from 23.7 to 21.2. In other words it is still expensive! (This was a month ago). Today SocGen put out an excellent piece titled “To Ignore CAPE is to Deny Mean Reversion” They use the MSCI earnings index that doesn’t include the writedowns and they come to the same conclusions as using the S&P series. 2. CAPE isn’t really a short term timing measure for one market. Like most valuation measures, it’s not that helpful telling you what to do for the next 6 months. It makes much more sense to align the indicator with your holdings period. Here is a post we did – Broadening the Window. However, pretty much every value measure we track aligns to say the same thing – US stocks are expensive. 3. But the biggest point that he misses, is that in a global world why focus on just the US? There are well over 40 investable countries in the world, why just settle for one? We have shown numerous times that selecting countries on a relative basis on CAPE works great to not only pick winners, but also to avoid the bubbly losers. And according to CAPE, the US is the second most expensive market we track right

8 now…and according to 1 year PE, it is the 4th most expensive…and according to P/B…etc If you do a composite across 10PE, 1PE, FCF, P/B, and dividends…the US is still the 4th most expensive… 4. Note the potential for margin mean reversion in the below chart from the SocGen piece….which side would you rather bet on? - See more at: http://www.mebanefaber.com/2013/08/22/what-siegel-is- missing/#sthash.HUlerv1U.dpuf 1. He talks about write downs and how that biases CAPE. The problem is, even if you ignored the bear market, even if the earnings decline of 2008,2009, 2010 never happened, effect on PE10 / CAPE would be mild- it would go from 23.7 to 21.2. In other words it is still expensive! (This was a month ago). Today SocGen put out an excellent piece titled “To Ignore CAPE is to Deny Mean Reversion” They use the MSCI earnings index that doesn’t include the writedowns and they come to the same conclusions as using the S&P series. 2. CAPE isn’t really a short term timing measure for one market. Like most valuation measures, it’s not that helpful telling you what to do for the next 6 months. It makes much more sense to align the indicator with your holdings period. Here is a post we did – Broadening the Window. However, pretty much every value measure we track aligns to say the same thing – US stocks are expensive. 3. But the biggest point that he misses, is that in a global world why focus on just the US? There are well over 40 investable countries in the world, why just settle for one? We have shown numerous times that selecting countries on a relative basis on CAPE works great to not only pick winners, but also to avoid the bubbly losers. And according to CAPE, the US is the second most expensive market we track right now…and according to 1 year PE, it is the 4th most expensive…and according to P/B…etc If you do a composite across 10PE, 1PE, FCF, P/B, and dividends…the US is still the 4th most expensive… 4. Note the potential for margin mean reversion in the below chart from the SocGen piece….which side would you rather bet on? - See more at: http://www.mebanefaber.com/2013/08/22/what-siegel-is- missing/#sthash.HUlerv1U.dpuf 1. He talks about write downs and how that biases CAPE. The problem is, even if you ignored the bear market, even if the earnings decline of 2008,2009, 2010 never happened, effect on PE10 / CAPE would be mild- it would go from 23.7 to 21.2. In other words it is still expensive! (This was a month ago). Today SocGen put out an excellent piece titled “To Ignore CAPE is to Deny Mean Reversion” They use the MSCI earnings index that doesn’t include the writedowns and they come to the same conclusions as using the S&P series. 2. CAPE isn’t really a short term timing measure for one market. Like most valuation measures, it’s not that helpful telling you what to do for the next 6 months. It makes much more sense to align the indicator with your holdings period. Here is a

9 post we did – Broadening the Window. However, pretty much every value measure we track aligns to say the same thing – US stocks are expensive. 3. But the biggest point that he misses, is that in a global world why focus on just the US? There are well over 40 investable countries in the world, why just settle for one? We have shown numerous times that selecting countries on a relative basis on CAPE works great to not only pick winners, but also to avoid the bubbly losers. And according to CAPE, the US is the second most expensive market we track right now…and according to 1 year PE, it is the 4th most expensive…and according to P/B…etc If you do a composite across 10PE, 1PE, FCF, P/B, and dividends…the US is still the 4th most expensive… 4. Note the potential for margin mean reversion in the below chart from the SocGen piece….which side would you rather bet on?

Conclusion from Lapthorne at SocGen: “At the peak of the cycle, when profits are far above average and the economy is doing well, it is hard to imagine earnings collapsing back below the average, as it is to imagine a depressed region recovering. Mean-reversion in earnings, though sometimes delayed, is as undeniable as the economic cycle itself. Cyclically adjusted (or trend) PE calculations will always give a conservative valuation estimate. But that is exactly the point of valuation – to offer a degree of safety (a margin of error) and to smooth the dangers of the economic cycle. That peak profits typically accompany peak valuations only reinforces the point. One can always discuss the idiosyncrasies of any particular valuation metric, although we reach similar conclusions to Robert Shiller’s CAPE analysis – but using a more modern time frame and a different (and more generous) earnings series. Our conclusions are that the US equity market is currently expensive. We can also reach a similar conclusion using alternative valuation metrics such as dividend yield, trend PE, and Tobin’s Q. Most significantly, the downside risk of investing when earnings and valuations are far above historical averages should not be underestimated. from our work, peak earnings go hand-inhand with peak valuations. When earnings revert back to mean (and below), the valuation will also collapse. That many continue to argue against this, and so soon after the collapse of 2008/09, is something we find quite remarkable. “ Jeremy Siegel talks about CAPE in a recent FT article. He has a few criticisms, but misses the bigger picture in my opinion. 1. He talks about write downs and how that biases CAPE. The problem is, even if you ignored the bear market, even if the earnings decline of 2008,2009, 2010 never happened, effect on PE10 / CAPE would be mild- it would go from 23.7 to 21.2. In other words it is still expensive! (This was a month ago). Today SocGen put out an excellent piece titled “To Ignore CAPE is to Deny Mean Reversion” They use the MSCI earnings index that doesn’t include the writedowns and they come to the same conclusions as using the S&P series.

2. CAPE isn’t really a short term timing measure for one market. Like most valuation measures, it’s not that helpful telling you what to do for the next 6 months. It makes much more sense to align the indicator with your holdings period. Here is a post we did – Broadening the Window. However, pretty much every value measure we track aligns to say the same thing – US stocks are expensive. 3. But the biggest point that he misses, is that in a global world why focus on just the US? There are well over 40 investable countries in the world, why just settle for one? We have shown numerous times that selecting countries on a relative basis on CAPE works great to not only pick winners, but also to avoid the bubbly losers. And according to CAPE, the US is the second most expensive market we track right now…and according to 1 year PE, it is the 4th most expensive…and according to P/B…etc If you do a composite across 10PE, 1PE, FCF, P/B, and dividends…the US is still the 4th most expensive… 4. Note the potential for margin mean reversion in the below chart from the SocGen piece….which side would you rather bet on?

Most significantly, the downside risk of investing when earnings and valuations are far above historical averages should not be underestimated. from our work, peak earnings go hand-inhand with peak valuations. When earnings revert back to mean (and below), the valuation will also collapse. That many continue to argue against this, and so soon after the collapse of 2008/09, is something we find quite remarkable. - See more at: http://www.mebanefaber.com/2013/08/22/what-siegel-is- missing/#sthash.XxbZgO7I.dpuf In the long run valuations mean everything. http://www.streettalklive.com/daily-x-change/1805-corporate-profits-what-siegel-is- missing.html

Larry Summers and the politicization of the Fed August 29, 2013 @ 5:00 pm By Felix Salmon Ezra Klein [1] has an excellent piece on Larry Summers today, basically saying that he’s “the overwhelming favorite” to become the next Fed chair just because he’s an old Clinton hand, and is trusted by all the other old Clinton hands with whom Barack Obama has surrounded himself. (Interestingly, that’s a phenomenon unique to the economic team: no other department exhibits the same trait.) The top slots on the economic team are all held by members of the Clinton clique. Sperling leads the National Economic Council. Lew is secretary of the Treasury. Furman is chairman of the Council of Economic Advisers. Sylvia Matthews Burwell, deputy director of the Office of Management and Budget during the Clinton administration, now heads OMB… It stretches credulity to believe that a pure meritocratic process has simply and ineluctably led to the same six or seven people cycling among positions. Klein’s thesis, when it comes to economic appointments, is that “the bar for each appointment is that the economic team already likes the candidate and knows he or she is good at the job and will work well with the other members of the team”. The reality of economic appointments to date is entirely consistent with that thesis, and I, for one, am convinced. But here’s the problem: such a mechanism is a bad idea in principle, a bad idea in practice, and an especially bad idea when it comes to the Fed chairmanship in particular. In principle, it’s even harder for a team like this one to learn from its mistakes than it is for an individual to do so. When the world changes, individual technocrats tend to change [2] with it. But when a small, close-knit team is put in charge of running the economic policy of the global hegemon, they create the facts on the ground. In practice, what that has meant is a depressingly predictable cycle of laissez-faire regulatory policy leading to crises, which are solved with massive bailouts, which leave the financial sector largely unscathed, and free to continue taking excessive risks, safe in the knowledge that if and when things blow up again, there will be yet another bailout. This cycle creates what I call Obama’s dangerously heroic view [3] of economic technocrats — a view which, it should go without saying, works very much to the advantage of the very advisers who have helped him develop it. It’s a view which places crisis-management skills far above crisis-prevention skills, and which considers crisis-management experience as being uniquely valuable. It’s also a view which makes it almost unthinkable for Larry Summers not to be nominated to the Fed: short of nominating Terry Checki [4] to the position, it’s hard to imagine a candidate with more crisis experience than Summers. But it’s one thing having groupthink within the White House — it’s the job of a disciplined executive branch to implement clearly-articulated policies, and if the populace doesn’t like it, they can kick the incumbents out at the next election. It’s something else entirely to take one of the most central — and most political — members of the White House team, and nominate him to lead the independent board of governors of the Federal Reserve.

Make no mistake: Summers would be the most political Fed chair in living memory. Greenspan was pretty bad, especially when he testified [5] — in clear support of the Bush administration’s tax cuts — that we had reason to be worried about budget surpluses. But Summers has been one of Obama’s closest economic advisers since the day that Obama took office: he’s much closer to Obama than Greenspan was to Bush. Summers has spent most of the past five years doing everything in his power to shape and advance Obama’s agenda. Obama, of course, is very happy about this, and would love to reward Summers for his loyalty by handing him the Fed chairmanship. Summers is not a consensus-builder; he’s the kind of person who, as chairman, would be convinced that he was right, and who would bully the rest of the board into doing exactly what he wanted them to do. (In this, he would have the active help of Obama, who would certainly nominate Summers-friendly names to the multitude of open board positions, and to the vice-chairmanship.) The result would be a central bank which had, to a first approximation, zero independence from the government, at least so long as Obama is president. A non-independent central bank is a bad thing; a bullying central bank chairman who’s determined to get his own way is also a bad thing. (The Fed is run by a diverse board of governors for a reason.) But put the two together, and you get a uniquely toxic combination, a way to fulfill all the craziest conspiracy theories of Ron Paul. Having what Klein calls the “Clinton clique” in sole command of Obama’s economic policy is bad enough. But it would be much worse if they essentially managed to engineer a hostile takeover of the Federal Reserve Board. When Tony Blair became prime minister of the UK in 1997, the first thing he did was to make the Bank of England independent. It was a signal that he was committed to orthodox economic policy, and that he was willing to be punished by an independent central bank should his policies go awry. It didn’t exactly work out that way, in the end, but his initial decision was clearly the right one, and came from a position of strength and self- confidence. If Obama nominates Summers to the Fed, the message will be the exact opposite: that he’s not going to be comfortable unless he can install his own man to run the show. Obama, it seems, can’t trust Yellen to do the right thing — or maybe he worries that her actions will reflect the consensus of the board as a whole, and will therefore be less predictable and controllable. So he’s going to pass her over, and put a political operative in charge instead, albeit a political operative with genuine economic chops. That’s a move even Clinton would never have dared make: he kept Greenspan at the Fed for his whole presidency. And it sets a horrible precedent: the next Republican president will henceforth have no compunctions whatsoever about appointing a party hack to the post. From here on in, if Summers gets the job, we won’t just be voting for president in presidential elections. We’ll be voting for Fed chair, too. And the Fed will become just as politicized as the Supreme Court has become. [1] Ezra Klein: http://www.bloomberg.com/news/2013-08-28/summers-pick-fits-obama-s-preference- for-beaten-path.html [2] change: http://blogs.reuters.com/felix-salmon/2013/02/07/how-does-tim-geithner-change-his- mind/ [3] dangerously heroic view: http://blogs.reuters.com/felix-salmon/2013/08/13/obamas-dangerously- heroic-view-of-the-fed/ [4] Terry Checki: http://www.newyorkfed.org/aboutthefed/orgchart/checki.html [5] testified: http://www.federalreserve.gov/boarddocs/testimony/2001/20010125/default.htm

Kohn-heads

Last night CNBC reported that “sources” were putting Larry Summers Fed Chair announcement soon. I have been a Don Kohn (former Vice-Chair, now Senior Fellow at Brookings) advocate and a couple days ago he gave his thoughts on policy. On the zirp: “Reduces the room for responding to further downward shocks, unexpected changes in market rate expectations, or errors in judgment reflected in too-early exit.”.. “the associated long period of extraordinarily low interest rates may have induced financial investment decisions that will result in losses and possibly even threats to financial stability as interest rates are raised.” what? there might be losses? UNPOSSIBLE On Exit: “sales of longer- duration securities on the books of central banks are not necessary to tighten monetary policy.” “The exit from unconventional policies might be especially disruptive given rates being as low as they will have been for as long as they will have been,”… “Nonetheless, individual central banks cannot be expected to steer away from the domestic objectives embodied in treaty, law, or remit – say by deliberately running inflation above or below the price stability objective – to help other jurisdictions reach their own domestic objective.” The last comment echoes our thoughts from last week that the age of co-operative Central banking is taking a time out. Domestic concerns will outweigh international-are you hearing this Indonesia, India and Brazil? Finally, he re-enforced the concept of transparency (a view we do not share) and added that if the CB were to screw it up (before short rates left the zirp) policy options would be extremely limited. Translation: we need the zirp to buttress the expansion and need to get away from it so we can lower rates in the next cycle downturn. Have fun Larry. http://thecontrariancorner.com/?p=11193

Daily Morning Newsbriefing August 30, 2013 Something has to got to give in Greece, quite soon This is an excellent article from Matina Stevis in the WSJ, worth reading in full. It goes through financing needs for Greece in more detail than the headline grabbing articles in the midst of an election campaign. Here are the main stop gaps of what needs to be decided in the next couple of months and why the current negotiation positions are not viable: • Greece faces an immediate cash shortfall of about €4bn this year and next. The European part of Greece's bailout, due to run out in December 2014, will in fact suffice only until next August. The IMF's programme extends until early 2016 in principle. But funding needs to be assured, otherwise IMF payments could be suspended. Thus despite all resistance, a new aid package is inevitable to support Greece from the autumn of 2014 until the end of 2016. The estimates range between €10bn and €15bn. EU officials say it will be dealt with in November. • Financing options and constraints: Another round of austerity in return for a bailout could well kill the fragile coalition government in Greece while one alternative source of funds, the €8bn in the bank recapitalisation fund, might well be needed by the banks early next year. To a large extent, Greece needs a third bailout to repay the first two. This year, it started paying back its IMF loans, €20.3bn must be repaid to the IMF between 2014 and 2016. Also, euro-zone central banks holding Greek government bonds are demanding that they be repaid at maturity, instead of allowing them to be rolled over, as had been expected. Athens now will need €5.6bn by 2016 to pay them off. • Beyond the third bailout, high debt levels need to be dealt with: The IMF extracted a commitment from euro-zone governments last November that, if Greece kept to the deal, they would take "additional measures" to cut its debt to "substantially below 110% of gross domestic product by 2022." The WSJ argues that unless Greece experiences a historically unprecedented and unlikely economic boom, that ratio can only be achieved if official creditors agree to take losses, something, European officials, German in particular, say is out of the question. Maturity extensions and a modest interest-rate cut is all that is on offer. The debt issue is likely to be dealt with in April next year, after EUROSTAT released the debt figures for 2012. Greece is trouble for the European-IMF relationship, though for now they agreed for Europe to deal with the shortfall in November and leave the debt issue to be dealt with next year.

Commission rebuffs idea of Luxembourg holding for Greek privatisation The European Commission vehemently rejected the idea of putting the Greek privatisation programme under the umbrella of a Luxembourg based holding, as a leaked report from the ESM to the FT suggested. “The ownership of this programme is, and absolutely must remain, in the hands of the Greek government,” said EC spokesman Simon O’Connor. Reports suggesting otherwise “have absolutely not been endorsed by the Commission or by the Eurogroup in any way” and they “have absolutely no status whatsoever,” O’Connor added. An ESM spokesman told Kathimerini that the report was “a background paper for the troika visit in September. The point of the paper was “to maximize the value of state-owned real estate assets in Greece by making them more attractive for investors.” After the tax deal in Rome: now comes the fight over VAT Deputy finance minister Stefano Fassina, agent provocateur of the left, yesterday triggered another big political spat with an article in the Italian Huffington Post, in which he criticised his own government’s decision, saying the abolition of the housing tax IMU on the first home would invariably lead to an increase in VAT. That comment almost triggered a political riot among Silvio Berlusconi’s PdL, which does not want this increase, and which would presumably quit the coalition if that were to happen. Most of the actual comments by the PdL about Fassina are not printable. The Italian media were yesterday digesting the implications of the new service tax, which will replace IMU, and which will mean a big reshuffle in the burden of taxation between various groups of society. The big winners of this decision are ordinary home owners. The big losers will be owners of secondary homes, and those who are renting, who will now be required to pay a kind of a poll tax, which combines elements of a tax on housing with those of various community services. La Repubblica has an article on the tenant’s union, which state the average tax on a tenant will be some 1000 Euros per year. It is interesting also that the Italians are referring to this new tax with its English name of service tax. Lucia Annunziata, the editor of the Huffington Post Italy, had a scathing comment on Berlusconi, who yesterday receive the official statement of the court, confirming his sentence on tax evasion. She writes: “The abolition IMU is the heart of its program, the very identity of the entire Forza Italy : do not pay taxes.” She is scathing about the proposal that the dirty deal on IMU would save the Letta administration. By this logic, she writes, the consistent thing to do would be to make Berlsuconi President of Italy, which would give permanent immunity. Boeri and Guiso on Italian banks Tito Boeri and Luigi Guiso have an article in Lavoce, in which they take a close look at the decrepit state of the Italian banking system. They write that eight banks were put under special surveillance by the Bank of Italy because of insufficient provisions for NPLs. They warn that the grip of the politically controlled banking foundations on the banking system has not changed, and is likely to impede the process of recapitalisation. They cite three concrete examples where this is the case: Banca Carige, Banco di Sardegna, and MPS. They write that the foundations work through political appointments, as a result of which banks are not run in an economically rational manner. They say that Renzi offers some hope to break through this (as he has frequently raised the issue of political appointments in the Italian economy). They suggest Renzi should advocate the separation of the foundations from the bank.

What would Peer Steinbruck do if he were chancellor? It is not easy to find out the content of Peer Steinbruck’s proposals from the coverage of the German media, which focused mainly on the presentation of his 100 day programme, combined with endless discussions of whether he can still close the gap in the polls to Angela Merkel. The SPD’s pages, however, lists the priorities for the first 100 days, which are: 1. a national minimum wage of €8.50; 2. law to force wage equalization between men and women; 3. a law to force equal wages for equal work (essentially the attempt to get rid of the practice by companies to replace staffers with cheap “imported” contract workers); 4. a pension reform to increase the pensions at the lower end; 5. abolition of a child care allowance and investment into public child care facilities; 6. acceptance of double citizenship without conditions; 7. a law to facilitate cheap housing; 8. an overhaul of financial reglation; 9. stepping up the fight against tax evasion; 10. Die Zeit writes that Steinbrück big European idea is his support for a banking union, and a bank-funded restructuring fund. The latter is very typical for the SPD’s policies on Europe. They demand what is already happening, and pretend that they are in any substantial way different. A bank funded restructuring fund will never be big enough to replace a sovereign guarantee. Like the CDU, the SPD does not want a genuine banking union. Spanish government estimates labour reform will accelerate job creation Spain's Employment minister Fátima Báñez appeared before the Employment Commission of the Spanish Parliament at her own request, reports Expansión. The minister said that the situation would be much worse had last year’s reform not been adopted. The government estimates the reform has avoided the loss of an additional 226 thousand jobs. Based on analysis of the growing export sector, Báñez claimed that, while before it was estimated that the Spanish economy needed to grow above 2% per year in order to create net employment, thanks to the reform this threshold will be halved and there will be job creation when growing above 1%. The most commented part of Báñez’ intervention was her announcement of an administrative simplification of the 41 different kinds of employment contracts. While this has been interpreted by headline writers, both in the Spanish and foreign press, as a reduction in the number of different contracts, commentators have pointed out that in reality all that the Minister announced is an administrative simplification of the forms on which the contracts are recorded. According to a ministry press release, the reform “retains the existing incentives, presenting the in a clearer fashion on a single form” for each of 5 kinds of contracts. Spain near zero growth Earlier this week Spain’s National Statistics Institute INE revised its GDP and employment series for 2009-2012, reducing real GDP growth estimates by a few tenths of a percent, and correcting down the nominal GDP and the GDP deflator in 2011 by over 1% (press release). The most salient finding is that the second dip of the recession started in the second quarter of 2011, one quarter earlier than previously estimated. The end of the second dip appears near, however, as the INE’s quarterly data released Thursday show a GDP drop of 0.1%. The contribution of external demand to nominal

GDP growth has been stable around 2% per year for about two years while domestic demand has been declining steadily for 3 years down to -4%. The data for the second quarter of 2013 break these trends. The data also show that unit labour costs are dropping at 2.3% per year, while the total wage bill is decreasing at 5%. Labour factor productivity is growing above 2% per equivalent full-time employee, but the series is quite noisy from quarter to quarter. Equivalent full time employment and total hours worked are dropping, but the hours worked per worker are going up. German inflation falls to 1.5% and Italian confidences rises marginally So much for adjustment. German inflation, having touched 1.9% in July, has fallen back to 1.5% in August, well below the ECB’s target, despite a large increase in food prices by 4.9% relative to August 2012. The main reason for the lower headline inflation is the fall in energy prices. In Italy, Istat reports that the composite business confidence climate index, which includes the manufacturing, construction, market services and retail trade sectors, increased from 79.8 in July to 82.2 in August. One Irish emigrates every six minutes Every six minutes one person leaves Ireland to live abroad, writes the FT, the highest number since modern records began in the late 1980s. New figures published on Thursday show 397 500 people have emigrated since Ireland’s financial crisis began in 2008, with most travelling to the UK, Australia and Canada in search of work. During the same period 277 400 people have returned or moved to Ireland, giving a net outward migration figure of 120 100. In a 12-month period from April last year, 10 people left every hour. More than a third of people leaving the country in the 12-month period to the end of April were between 15 and 24 years of age. Some 50 900 of the 89 000 people who emigrated were Irish citizens while the rest were nationals from other countries. Portugal’s court rejects bill to fire public workers Portugal's Constitutional Court dealt a new blow to the government's austerity efforts under an EU/IMF bailout by rejecting a bill that would have effectively allowed the state to fire public sector workers after a requalification period, Reuters reports. The bill's direct impact on the 2014 budget deficit is relatively low, but it is considered important because of its potential effect on spending cuts. The rejection also sends an alarm signal to investors as more planned austerity measures could be thrown out, endangering bailout targets. Portuguese law had long prohibited layoffs of public employees except for gross misconduct or other exceptional circumstances. That changed when Parliament last month modified the terms of a retraining program for public employees deemed to be redundant. The court ruled the measure unconstitutional, saying it violates "guarantees of secure employment" and the principle of trust between employer and employee. The court delivered its unanimous decision two weeks before deadline, writes the FT. Six of its 13 judges were on holiday and did not participate in the ruling. The bill had been sent to the court for vetting by President Aníbal Cavaco Silva. The opposition has vowed to go to the court to challenge other austerity measures including an extension of the work week to 40 hours from 35, according to the WSJ.

Breakingviews on the rise in the put option premium of the euro/dollar rate Swaha Pattanaik of Reuters Breakingviews writes that the complacent market mood on the euro’s exchange rate during the summer is in the process of turning around. Demand for euro-dollar put options is outstripping demand for call options, as they now carry the highest price premium for the year. The implied volatility of the exchange rate has also risen, breaking through normal empirical ranges. These trades are driven by international investors with euro assets who use put options to protect themselves against the risk of a drop in the currency. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.584 0.596 0.592 Italy 2.538 2.518 2.519 Spain 2.662 2.687 2.687 Portugal 4.761 4.776 4.817 Greece 8.533 8.508 8.44 Ireland 2.240 2.278 2.269 Belgium 0.874 0.881 0.879 Bund Yield 1.878 1.855 1.854

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.327 1.3237

Yen 130.100 129.92

Pound 0.855 0.8524

Swiss Franc 1.230 1.2324

ZC Inflation Swaps

previous last close

1 yr 1.27 1.23

2 yr 1.46 1.41

5 yr 1.65 1.62

10 yr 1.98 1.96

Euribor-OIS Spread

previous last close

1 Week -4.914 -4.914

1 Month -2.243 -2.543

3 Months 3.157 3.957

1 Year 30.700 28.2

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-08- 30.html?cHash=1fb82d792929877598b0cd2bc096f2cb

August 29, 2013 The Unsaved World By PAUL KRUGMAN The rupiah is falling! Head for the hills! On second thought, keep calm and carry on. In case you’re wondering, the rupiah is the national currency of Indonesia, and, like many other emerging-market currencies, it has fallen a lot over the past few months. The thing is, the last big rupiah plunge was in 1997-98, when Indonesia was the epicenter of an Asian financial crisis. In retrospect, that crisis was a sort of dress rehearsal for the much bigger crisis that engulfed the advanced world a decade later. So should we be terrified about Asia all over again? I don’t think so, for reasons I’ll explain in a minute. But current events do bring back memories — and they are, in particular, a reminder of how little we learned from that crisis 16 years ago. We didn’t reform the financial industry — on the contrary, deregulation went full speed ahead. Nor did we learn the right lessons about how to respond when crisis strikes. In fact, not only have we been making many of the same mistakes this time around, in important ways we’re actually doing much worse now than we did then. Some background: The run-up to the Asian crisis bore a close family resemblance to the run-up to the crisis now afflicting Greece, Spain and other European countries. In both cases, the origins of the crisis lay in excessive private-sector optimism, with huge inflows of foreign lending going mainly to the private sector. In both cases, optimism turned to pessimism with startling speed, precipitating crisis. Unlike Greece et al., however, the crisis countries of 1997 had their own currencies, which proceeded to drop sharply against the dollar. At first, these currency declines caused acute economic distress. In Indonesia, for example, many businesses had large dollar debts, so when the rupiah plunged against the dollar, those debts ballooned relative to assets and income. The result was a severe economic contraction, on a scale not seen since the Great Depression. Fortunately, the bad times didn’t last all that long. The very weakness of these countries’ currencies made their exports highly competitive, and soon all of them — even Indonesia, which was hit worst — were experiencing strong export-led recoveries. Still, the crisis should have been seen as an object lesson in the instability of a deregulated financial system. Instead, Asia’s recovery led to an excessive showing of self-congratulation on the part of Western officials, exemplified by the famous 1999 Time magazine cover — showing Alan Greenspan, then the Fed chairman; Robert Rubin, then the Treasury secretary; and Lawrence Summers, then the deputy Treasury secretary — with the headline “The Committee to Save the World.” The message was, don’t worry, we’ve got these things under control. Eight years later, we learned just how misplaced that confidence was. Indeed, as I mentioned, we’re actually doing much worse this time around. Consider, for example, the worst-case nation during each crisis: Indonesia then, Greece now.

Indonesia’s slump, which saw the economy contract 13 percent in 1998, was a terrible thing. But a solid recovery was under way by 2000. By 2003, Indonesia’s economy had passed its precrisis peak; as of last year, it was 72 percent larger than it was in 1997. Now compare this with Greece, where output is down more than 20 percent since 2007 and is still falling fast. Nobody knows when recovery will begin, and my guess is that few observers expect to see the Greek economy recover to precrisis levels this decade. Why are things so much worse this time? One answer is that Indonesia had its own currency, and the slide in the rupiah was, eventually, a very good thing. Meanwhile, Greece is trapped in the euro. In addition, however, policy makers were more flexible in the ’90s than they are today. The International Monetary Fund initially demanded tough austerity policies in Asia, but it soon reversed course. This time, the demands placed on Greece and other debtors have been relentlessly harsh, and the more austerity fails, the more bloodletting is demanded. So, is Asia next? Probably not. Indonesia has a much lower level of foreign debt relative to income now than it did in the 1990s. India, which also has a sliding currency that worries many observers, has even lower debt. So a repetition of the ’90s crisis, let alone a Greek-style never-ending crisis, seems unlikely. What about China? Well, as I recently explained, I’m very worried, but for entirely different reasons, mostly unrelated to events in the rest of the world. But let’s be clear: Even if we are spared the spectacle of yet another region plunged into depression, the fact remains that the people who congratulated themselves for saving the world in 1999 were actually setting the world up for a far worse crisis, just a few years later. http://www.nytimes.com/2013/08/30/opinion/krugman-the-unsaved- world.html?partner=rssnyt&emc=rss

Daily Morning Newsbriefing

August 29, 2013 Berlusconi’s triumph Absolute victories are rare in modern politics, but this is exactly what happened in Italy yesterday when Silvio Berlusconi prevailed with the abolition of a housing tax, which will open up a large fiscal gap for this year, which has yet to be plugged. The abolition of the tax was Berlusconi’s main campaign theme, and he got exactly that. We also believe that he will obtain his other demand – a refusal by the Senate to lift his immunity – as a result of which we now expect the Letta administration to last for possibly much longer than the pundits had originally estimated. Yesterday’s agreement by the Italian cabinet foresees the total abolition of the IMU property tax on the first residence, and its replacement by a service tax, under which the tax burden is spread more widely (economically a relative redistribution of wealth towards home owners). The June instalment of the IMU had already been suspended. The December instalment will also be suspended, with counter-financing measures of €4bn still to be decided, but likely to include a hodgepodge of measures, such as gambling taxes. The total annual tax take from IMU accounts for €24bn, which now needs to be raised by different means. Bond yields predictably dropped yesterday, as the agreement took investors by surprise – despite the fact that Italian newspapers reported yesterday that the parties were working on a compromise. Silvio Berlusconi reacted with exuberance, saying that this was case of a return of the “ethics of politics”, as politicians have delivered what they promised in an election. A visibly relieved Letta called the decision balanced. Mario Monti called the agreement a defeat for Letta and Fabrizzio Saccomanni and for the Partito Democratico. This was also the main theme of Italian political commenters. Massimo Giannini, writing in La Repubblia, says that the abolition of IMU would create a huge budgetary hole for the municipalities. The cancelations of the second instalment of IMU is not counter-financed, with no clarity until October. As for the services tax, this is probably going to end up as a similar tax with a different name. Writing in Corriere della Sera, Massimo Franco says that it will now be much harder for Letta’s opponents to bring down the current government than expected. The main impact of all this is political, not economic. For us, it signals that the Letta administration is likely to survive, possibly even last a full term, but that it will only contend itself with cosmetic reforms, shifting taxes and spending around a bit – but not by much – as is now clearly the case here. The IMU tax will be replaced with a similar tax, yielding a similar amount of revenue, except that some Italians pay more, and some less. The agreement will do nothing to stimulate growth.

Spain to sell publicly owned land and buildings In a story not covered by major Spanish media, Le Monde writes that the Spanish government is planning on putting “one quarter of the national heritage” up for sale in order to rein in the budget deficit. The approximately 15,000 properties to be sold include land around railway and road right-of-ways, emblematic buildings in major cities, and even wild spaces, some of them protected as natural parks. Spaniards emigrating to Morocco Bloomberg spices up a run-of-the-mill story about Spain’s unemployment crisis by focusing on Spaniards “fleeing to Morocco” to escape the “jobless scourge”, but without giving any numbers on the migratory flows between the two countries. On the substance, Bloomberg recounts a number of shocking but well-known statistics: 1/3 of all Eurozone unemployment is in Spain; migration into Spain halved in the 4 years following 2008, while migration to Europe, Latin America and, yes, Morocco, rose; youth unemployment stands at 56% and many youth are leaving the workforce, with a substantial fraction doing so by emigration. Spain leads Eurozone credit contraction El País reports that outstanding loans in the Eurozone dropped 1.9% in July, the largest monthly drop in the history of the Euro and the 15th consecutive month of decline. For nonfinancial firms the drop is 3.5%, nearly twice as large. M3 grew at an annual pace of 2.2 percent in July, down from 2.4% in June. The crisis countries show the largest year-on-year drops, with Spain far in the lead with a drop of more than 10%, followed by 5.5% in Portugal. Spanish bank deposits by households dropped by 1.9%, with deposits by firms also declining. El País, also quotes Reuters on the decline in the sovereign bond holdings by the banking sector in Spain, France and Italy. Banks’ sovereign debt portfolios are at their lowest size in a year. EU plans Luxembourg-based holding to speed up Greek privations Eurozone finance ministries are considering a big overhaul of Greece’s privatisation programme that would move most of the state-owned real estate intended for sale into a Luxembourg-based holding company managed by foreign experts, the FT reports. Under the plan, the new holding company would be empowered to manage the real estate portfolio independently from Greek government interference, including raising cash against the portfolio’s value to either pay down government debt or improve some of the lots. The Greek government would still retain control of the real estate, however, and it would be up to Athens to ultimately decide when to sell. Greece’s current real estate sales programme covers up to 80,000 state-owned buildings, tourist facilities and plots. Only a handful of deals have been completed because of problems with uncovering ownership, zoning rules and obtaining clearances from the archaeological service. The proposal is likely to meet with political resistance in Greece. Far-left SYRIZA already called the plan “a blow to national sovereignty and dignity”. Teachers Union to sue over mobility scheme The Federation of Secondary School Teachers (OLME) said Wednesday that it would take legal action against the Greek government’s plan to put thousands of teachers into

25 the mobility scheme, Kathimerini reports. “We do not accept the decisions of the government and the education minister to put our colleagues on standby,” the union said, referring to Constantinos Arvanitopoulos, whose talks earlier this week with unionists failed to yield a compromise. OLME unionists are to convene again on Thursday to decide on the type and duration of strike action next month. Their decision will be subsequently be put to local unions for approval. Greece found 10% of hired civil servants used fake qualifications Alternate Interior Minister Leonidas Grigorakos called for the qualifications of all civil servants hired in the past 20 years to be rechecked for authenticity. He said a probe revealed that of the 850,000 new hirings from 2004 to 2009, 10% were found to be based on false education certificates. Speaking to Kathimerini, Grigorakos called for the appointment of an independent authority headed by a judicial official tasked with checking the legitimacy of all civil servants’ education qualifications. IMF reaffirms call for wage flexibility for Portugal Reacting to the revealed data incompleteness the IMF issued a statement saying that its call for more wage flexibility was not based on this single indicator alone but a set of indicators. It recognized to be reviewing the quality and completeness of the database but said that this does not alter its stance on demanding more nominal wage flexibility from Portugal, Jornal de Negocios reports. The newspaper made a big story out of its findings that using the complete data set for 2012 the share of wage cuts is 27% and not 7% as reported by the IMF in its review. The context is that nominal wage cuts are a controversial issue and has recently caused tensions between the Portuguese government and the IMF. The government argues that there is no scope for more cuts after the efforts in the last couple of years, according to the newspaper. Hulverscheidt on Schauble Claus Hulverscheidt, writing in Suddeutsche Zeitung, is wondering why Wolfgang Schauble has come out with the acknowledgement that another rescue package for Greece, in the order of €11bn, is likely. He writes the CDU is split over whether this has been a good idea to say this openly during the election campaign. Schauble may have chosen to come clean on this simply to remove all accusations of electoral fraud he is likely to face if the truth came out in the immediate aftermath of the elections. Hulverscheidt says the risk is that this would give the anti-euro party AfD – which has not succeeded so far – a much needed momentum in the hot phase of the campaign. As for the estimate itself, Hulverscheidt says the Greek funding needs are significantly higher than what Schauble now acknowledges in public. Munchau endorses a coalition of the Left in Germany In his Spiegel Online column, Wolfgang Munchau endorses what is almost certainly the least likely outcome of the German elections, a coalition between SPD, Greens, and the Left Party. Taking a detailed look at the Left Party’s election manifesto, he finds - beyond the usual redistributive nonsense - a rather literate analysis of the eurozone crisis, which the Left defines as a crisis of capital flows first and foremost – not of fiscal indiscipline. In that point, the Left Party is in agreement with the Greens, the latter unfortunately having supporting Angela Merkel’s policies, while the Left has been much more consistent. For the SPD, which wavers on the crisis, a coalition with the Left would make much more sense than a Grand Coalition because it would otherwise co-share all the consequences of Merkel’s crisis policies if it enters a Grand Coalition with the CDU. In that case, the Left and the Greens would have a field day when these

26 policies unravel, which they eventually will. Munchau thus disagrees with the prevailing consensus among commentators that the Left Party’s position on the eurozone crisis precludes any coalition. Munchau argues the very opposite is the case. Das says there is No Way Out for the eurozone Writing in the Financial Times, Satyajit Das says the eurozone had a year of truce, thanks to the ESM and the OMT, but this is likely to be a calm before the storm as the policies are not working. There is little scope for further debt write-offs, as official lenders are now engaged. He sees the following scenario: first, a lack of economic growth will increase pressure on Germany to assume an increasing share of the liabilities. Second, he estimates that European banks have €1tn in non-performing loans, so that the eurozone will end up with zombie banks, further restricting the recovery. Third, the pace of structural reforms will be slow, as the calm of the last 12 months lured governments into a false sense of security. Fourth, there will be a rise in political tensions. He says this is case of No Way Out. Sinn on the exemption of secured debt from the bailout regime Writing in the Guardian, Hans Werner Sinn focuses on the exemption of secured debt from the pecking order in the new bailout regime. The secured debt relates mainly to the ECB’s refinancing operations, the total of which amounts to €732bn for Cyprus, Greece, Ireland, Italy, Portugal, and Spain. These loans exceed the normal liquidity requirements of these countries, which he puts at a maximum of €335bn, for which the available stock of central-bank money would have sufficed. As several banks in these countries are on the verge of bankruptcy, many of these loans have turned toxic. If the ECB were to participate in the write-office, it would risk huge losses. Instead, these losses are now transferred to the ESM. “This makes no difference to taxpayers, who will have to pay for both institutions' losses in the same manner. But it has the advantage of allowing the ECB to present itself as having a clean balance sheet, thereby enabling it to maintain its current policy.” Krugman on Indonesia and Greece Writing in his. Paul Krugman compares Indonesia, whose currency is currently plummeting, and Greece. He makes the point that Indonesia was the equivalent of Greece in the Asian crisis with similar structural problems, but unlike Greece, Indonesia managed to bounce back quickly – the reasons being a currency devaluation and the IMF’s decision to go soft on austerity after a while. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.591 0.584 0.578 Italy 2.608 2.510 2.495 Spain 2.652 2.662 2.629 Portugal 4.754 4.761 4.817 Greece 8.473 8.533 8.47 Ireland 2.218 2.240 2.225 Belgium 0.899 0.874 0.868 Bund Yield 1.848 1.878 1.893

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.338 1.3275

Yen 130.250 130.26

Pound 0.863 0.8554

Swiss Franc 1.229 1.2293

ZC Inflation Swaps

previous last close

1 yr 1.2 1.27

2 yr 1.4 1.46

5 yr 1.52 1.65

10 yr 1.99 1.98

Euribor-OIS Spread

previous last close

1 Week -6.543 -3.643

1 Month -2.886 -1.386

3 Months 4.843 5.043

1 Year 29.229 29.929

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-08- 29.html?cHash=b90c8f00c944432b0349cb696411845a

Daily Morning Newsbriefing

August 28, 2013 A deal in Italy is getting closer These are rather dull news day for eurozone news – a combination of the summer holiday break and the media focus on the approaching military strike against Syria. Today’s main story is the now likely compromise between Italy’s quarrelling coalition partners over the housing tax IMU. We always thought that the threats by Silvio Berlusconi’s loyalists to run out of the coalition were empty, as this would expose their great leader to a certain period of house arrest unless he were to win an improbable absolute majority in a snap election. The noise level over the weekend was designed to put pressure on the Partito Democratico to compromise over the housing tax IMU, the abolition of with was the PdL’s main campaign theme. The tactic to take this coalition to the brink seems to have paid off. La Repubblica reports this morning that the two parties have edged towards a compromise ready for a crucial cabinet meeting today. Under this compromise, Enrico Letta would accept the PdL’s key demand of the abolition of IMU on primary residences, and, presumably, its replacement with other taxes. La Repubblica reports on the options being discussed – taxes on banks, or a local service tax among them. The compromise has been worked out in several high level meetings between PdL leaders and Fabrizio Saccomanni yesterday. The macroeconomic implications of this measures are unlikely to be relevant, but the expected agreement will increase the life-span of the Italian grand coalition. Separately, Italian media also reporting about a possible compromise over Silvio Berlusconi’s jail term, which would remove the last short-term threat to the Letta administration. The latest political manoeuvres did not yet have any impact on the BTP spreads, which continued to widen yesterday as investors took fright at the prospect of political instability in Italy. The Italian media are obsessed with “il sorpasso”, the dreaded moment when Italian spreads exceed Spanish spreads. The spread of the two spreads has narrowed – as Corriere della Sera documents in this morning’s edition –but is still intact – 264.5bp for the Bonos/Bund spread again 260bp for the BTP/bund spread. We do not think that the Italian government is about to fall. The main disappointment with the Letta administration is an unbelievable lack of ambition, and its focus on economically largely irrelevant issues, such as IMU property tax. But if a final deal is reached today, which the La Republicca story seems to suggests, then one must at least concede that the coalition works better on a political level in contrast to what has been predicted. This is probably due to the fact that neither of the two main parties in the coalition has an interest in new elections. Spain’s INE documents continued mortgage slump Spain’s National Statistics Institute INE released data on the mortgage market showing a drop in both volumes and loan amounts. Overall, the number of residential mortgages

made in the first 6 months of the year dropped by just under 24% from a year earlier, with the average amount down 9% to over €97k. over 80% of mortgages are indexed to Euribor and just over 8% are fixed-rate. The average initial interest rate has oscillated between 4.12% and 4.58% in the past year, and was 4.43% for June 2013; the average term is 19 years. Ayrault’s small pension reform Jean-Marc Ayrault announced the parameters of the pension reform at the end of two days consultations with trade unions and employers. The result is a pension reform that raises the level and duration of contributions, avoiding the more radical reform demanded by the EU. Faced with a deficit set to reach €20.7bn by 2020 efforts to reduce the deficit will be covered almost exclusively by an increase in the pension contributions, which is set to yield €7.3bn. Only from 2020 the contribution period will be lengthened progressively to 43 years, expected to raise €2.7bn annually as from 2030 and twice as much from 2040. These are the backbones of the pension reform as reported by the FT and Les Echos · Contributions by both employees and employers will rise progressively over four years to total an increase of 0.3 percentage points in 2017 – or €4.50 per month for a worker on the minimum wage. · The contribution period required to earn a full pension will not change before 2020, but will then rise from the present period of 41.5 years to 43 years by 2035. This will hit the generation born after 1973. All those who start in the job market at the age of 26 will only get a full pension when they work until the age of 70. · A hardship pension will be introduced from 2015 to help the estimated 20 per cent of employees who have worked under tough conditions. More measures in favour of women rights. Educational training and unemployment will be better taken into account. Reactions among Trade unions, employers and political parties are mixed. The hard-line trade union CGT said it was not listened to and announced strike actions for September 10. Pierre Gattaz, the new head of MEDEF told Le Figaro “This is a dangerous reform that is not acceptable to us. In truth it is a non-reform: no structural problem is resolved.” Newspaper editorialists as seen by Le Monde either accused Ayrault of lacking courage for a bolder reform or applauded how he managed to demine the contentious reform battle field. Greece may ask for more time in public sector reform Greece might ask troika for an extension to a December 31 deadline for finding another 12,500 civil servants to be moved into the mobility scheme, Kathimerini reports. Reform Minister Kyriakos Mitsotakis said that the first round is on track, moving 12,000 civil servants to the mobility scheme by the end of next month. But he conceded that it will not be so easy to put another 12,500 employees into the same scheme a few months later. Sources indicated that a request to extend the deadline is only likely to be made in the event that the troika issues a positive report on Greece’s progress with economic reforms. Questioned about layoffs in the civil service, which Greece must also carry out in parallel to the mobility scheme, Mitsotakis said the majority of dismissals would involve civil servants who have been found guilty of disciplinary offenses, some of which would come from the mobility scheme. Meanwhile, the secondary teachers’ union were planning to scale up their protests planned for mid-

September. Mitsotakis warned in an interview with Mega TV that the government will not tolerate closed schools, not even for one day. Portugal’s wage cuts were higher than IMF suggests Jornal de Negocios reports that data used by the IMF to portrait the wage development in 2012 were incomplete. A graph in the seventh assessment report showed that in 2012 only 7% of the wage contracts reinforced wage cuts, in 45% of the cases wages were freezed. On this basis the report stressed the importance of further wage cuts. But the newspaper now found out that the basis for this argument is wrong, underestimating the size of the salary reductions registered in the database of Social Security. In the sample of about 18,000, 4,000 were missing in 2012. Including those results in a 20% rate of wage reductions. German Ifo index rises again In Germany, the economic recovery is clearly taking hold as evidenced by the fourth consecutive increase in the Ifo index in August. The main index increased by 1.3 points to 107.5, driven by industry, as reported by Frankfurter Allgemeine, especially the car industry, which had suffered badly in the previous downturn. Expectation of future exports have also risen strongly. The biggest dampener is the construction industry. The FT’s coverage was more downbeat, focussing on the fall in gross fixed capital formation, which has fallen for the fifth consecutive quarter. The article says the reluctance by manufacturers to invest reflects caution about the markets in which they operate. The article quotes Jorg Kramer of Commerzbank as saying that the Ifo frequently decoupled from underlying trends in emerging markets. The article also noted that companies have been getting gloomier, quoting views from BASF, Siemens and others. Harding on financial flows Robin Harding, the FT’s man at the Jackson Hole conference, has a comment in which he warns of a re-run of the financial crisis, as the world fails to reform its financial system in order to stem global imbalances. He quotes from a paper by Helene Rey, arguing that the Fed’s monetary policies are so highly distortive that countries cannot even protect themselves through a floating rate. They thus face the choice of tying themselves to the Fed or to impose capital controls. Harding said the acceptance by the Jackson Hole participants of this gloomy analysis was striking. He disagrees with Rey’s policy recommendation of capital controls and policies to dampen down credit booms on the grounds that for this to be effective globally, it would require an unrealistic degree of policy co-ordination. He says the best course of action would be large-scale monetary system reform of the kind discussed shortly after the collapse of Lehman Brothers, which would control global capital flows by bearing down on countries with large surpluses. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.563 0.591 0.591 Italy 2.496 2.653 2.674 Spain 2.570 2.652 2.631 Portugal 4.718 4.754 4.817 Greece 8.220 8.473 9.55

Ireland 2.104 2.218 2.236 Belgium 0.881 0.899 0.912 Bund Yield 1.893 1.848 1.827

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.334 1.3379

Yen 130.580 130.16

Pound 0.860 0.8626

Swiss Franc 1.230 1.2285

ZC Inflation Swaps

previous last close

1 yr 1.45 1.2

2 yr 1.41 1.4

5 yr 1.52 1.52

10 yr 2 1.99

Euribor-OIS Spread

previous last close

1 Week -6.643 -6.643

1 Month -2.886 -2.886

3 Months 2.543 4.443

1 Year 30.829 29.429

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-08- 28.html?cHash=3089e04eb9d3df607bc92092f62f27fa

Summers Pick Fits Obama’s Preference for Beaten Path By Ezra Klein - Aug 28, 2013 At this point, Larry Summers isn’t just the favorite for Federal Reserve chairman. He’s the overwhelming favorite. Unless something truly unexpected shows up in the vetting process (a paid toast at Bashar al-Assad’s birthday party, for example) or the administration comes to believe Senate Democrats will revolt against a Summers nomination, he’s going to get the job. That shouldn’t come as a shock. A close look at the rest of President Barack Obama’s economic appointments makes clear that the shock would be if he didn’t go with Summers. An early surprise of the Obama administration was how much it looked like the Clinton administration, at least on the economics side. Summers was back. So were Tim Geithner, Peter Orszag, Jason Furman, Gene Sperling, Jack Lew and Mike Froman. “Barack Obama has succeeded where Hillary Clinton failed,” wrote Rich Lowry in the National Review. “She hoped to win a third Clinton term, but it is her vanquisher who is reconstituting the Clinton administration.” Obama’s reliance on Clinton-era econ whizzes was sensible. As a relative newcomer to national politics he didn’t have a network of economic experts of his own to choose from, and given the severity of the economic storm, there wasn’t time for his team to learn on the job. Culling experienced crisis managers from the last Democratic administration was the obvious choice. And even as Obama appointed a number of familiar faces, he brought some new voices to his economic team, too. Christina Romer, the famed economist from the University of California at Berkeley, was tapped to lead the Council of Economic Advisers. Obama’s longtime economic adviser Austan Goolsbee was placed in charge of the Economic Recovery Advisory Board. Jared Bernstein, a labor economist much loved by liberals, was asked to serve as the top economist to Vice President Joe Biden. Clinton Clique Four years later, any newcomers Obama appointed are gone. The top slots on the economic team are all held by members of the Clinton clique. Sperling leads the National Economic Council. Lew is secretary of the Treasury. Furman is chairman of the Council of Economic Advisers. Sylvia Matthews Burwell, deputy director of the Office of Management and Budget during the Clinton administration, now heads OMB. A glance at Obama’s second-term foreign policy team makes clear how unusual this is. John Kerry was recruited from the Senate to serve as secretary of state. Former Senator Chuck Hagel was named secretary of defense. Samantha Power -- a Pulitzer Prize winner and academic superstar who had to step down from Obama’s 2008 campaign for calling Hillary Clinton “a monster” -- is United Nations ambassador. Denis McDonough, a foreign policy adviser to Senator Tom Daschle and then to Senator

Obama, is now chief of staff. The only Clinton administration veteran is Susan Rice -- and she made a high-profile break with her former peers to endorse Obama in 2008. The economic team’s insularity is often attributed to the influence of ex-Treasury Secretary, ex-Goldman Sachs & Co. Co-Chairman, and ex-Citigroup Inc. Director Robert Rubin. The case is usually made by way of a vigorous game of six-degrees-to- Bob-Rubin. Summers and Sperling were both his deputies. Burwell was his chief of staff. Lew worked with him at Citigroup. Furman ran his think tank. QED. Rubin served at the top levels of the Clinton administration -- as NEC director, and then as Treasury secretary -- from 1993 to 1999. Sperling wasn’t quite as senior as Rubin, but he hired Furman, Orszag and Burwell to some of their early jobs, and discovered Deputy OMB Director Brian Deese. But nobody talks about Sperling-ism -- even though, unlike Rubin, he actually serves in the Obama administration, and regularly speaks with the president. Rubin’s absence -- and relative lack of influence with Obama himself -- makes the team’s persistence all the more striking. Few professional networks strengthen themselves across multiple terms of multiple administrations once their main patron departs. This one has. Democratic Consensus The reason commonly assumed is ideology, and there’s something to that. The team has disagreements -- Summers was relatively more interested in stimulus and less interested in deficit reduction than Geithner, for example -- but they’re not vast. All its members exist comfortably in the center-left consensus that currently dominates Democratic politics: taxes on the rich should be higher, the safety net for the poor should be more generous, and government should be careful when interfering in the market. It’s a consensus that Obama shares, but one that many other Democratic economic policy wonks share, too -- Obama would have no problem finding new recruits to carry out that vision. As such, it doesn’t really explain why he’s stuck to this one network. Privately, members of Obama’s economic team think the answer is that they’re just really, really good at their jobs. It’s a self-serving argument, to be sure, but that doesn’t mean it’s wrong. The Clinton administration had, by most accounts, a high-functioning economic team, and these are the people who rose highest and fastest within it. Running a White House’s economic policy is a tough and unusual job, and not that many people have experience doing it. That combination of good and qualified is rare in the world, but it happens to be common among this one group of people. If this team wasn’t good, well, Obama’s management of his foreign-policy team shows he’s perfectly happy to try out new faces and develop his own people. The fact that he has stuck to the same people prized by Rubin and Clinton on the economic side merely shows that these people are really good. There’s truth to that. But it stretches credulity to believe that a pure meritocratic process has simply and ineluctably led to the same six or seven people cycling among positions. Meritocracy is an element in the team’s success, but so is the fact that when it comes to his economic team, Obama doesn’t take chances. In interviews with current and former administration officials who served both on and off the economic team, one theme keeps recurring: It’s impossible to overstate how formational the experience of the financial crisis was to Obama’s presidency.

Risk Aversion And it wasn’t just the financial crisis. There’s also been the European debt crisis, the unexpected debt-ceiling crisis and the lingering jobs crisis. The extended firefighting forged strong bonds between Obama and his top policy makers. More than that, it led the president to a deep risk aversion when appointing new members of the team. The heavy knowledge that the economy can fall apart at any moment makes it dangerous to take a flier on some untested newcomer. But if the bar for each appointment is that the economic team already likes the candidate and knows he or she is good at the job and will work well with the other members of the team, then the only people who will clear the bar are people the economic team has already worked with. And because all the members of the team have similar backgrounds that brought them in contact with many of the same people, the same people get chosen again and again. There’s a real element of merit in this, in the sense that it wouldn’t work if Obama didn’t genuinely think his economic team was doing a superlative job. So long as he is pleased with the job they’re doing, the path dependence is almost unbreakable. This basic model fits every major economic appointment Obama has made since taking office. It explains why the president has named only one person who wasn’t in the administration in 2009 to a top economic position -- Burwell, who served with (and impressed) every other member of Obama’s economic team in the Clinton administration. And it explains why Obama strongly favors an inside candidate such as Summers for the most important economic appointment of all. (Ezra Klein is a Bloomberg View columnist.) To contact the writer on this article: Ezra Klein in Washington at [email protected]. To contact the editor responsible for this article: Max Berley at [email protected]. http://www.bloomberg.com/news/2013-08-28/summers-pick-fits-obama-s-preference- for-beaten-path.html

Daily Morning Newsbriefing

August 27, 2013 Some progress in Italy, but government crisis remains on knife-edge For some the situation in Italy is akin to the calm before the storm. For others it is another loud Italian storm in a teacup. While the PdL hardliners are openly threatening the end of the coalition, Silvio Berlusconi yesterday tried to tone down the debate with an appeal to his loyal followers to calm down, and not to be cajoled into making extreme statements, which the press would undoubtedly seize upon. The critical issue for this week is tomorrow’s cabinet meeting on the housing tax IMU. Within the Letta government, some progress has been made to achieve a compromise. Angelino Alfano, deputy PM and PdL general secretary, expressed cautious optimism that a solution could be found to abolish the IMU tax on the first home, as the PdL has promised during the campaign, a pledge it wants to keep fully. Alfano said yesterday, more work needed to be done, but an agreement was feasible. Corriere della Sera offers details of the discussion on how to plug the funding gap of some €4bn. Enrico Letta has signalled readiness to compromise on this issue – but only in respect of IMU tax payments on first residences due in 2013. The Letta administration also yesterday decided on a string of economic reform measures, in particular an agreement to fund a large number of Italians who have fallen through the social net with no employment and no pensions, and with the establishment of an agency to organise the use of EU structural funds, as Italy is not making full use of its entitlements to co-financed projects from Brussels. Bond markets yesterday reacted nervously to the threats over the weekend. The 10-year spread rose from 239bp on Friday to 250bp yesterday, and the Italian stock market index lost some 2.1%, with Berlusconi’s Mediaset down 6.25%, Corriere writes. Fubini on the dangers ahead In a commentary in La Repubblica, Federico Fubini writes that Italy’s positive current account balance is not a sign that the crisis has ended, but a sign of the depth of the recession. The crisis will only be over when Italy has a surplus without 3m unemployed. He notes a report by the Bank of Italy according to which the country had now entered a different phase. But this sentiment is not yet shared by the markets. He identifies two risk factors, a further downgrade by the rating agencies, and the lack of a functioning central government. He compares the situation in Italy to that of Greece and Portugal, where investors reacted extremely negatively to government crises, but reversed quickly when the political situation improved. He writes that investors want to have some certainty about the future – which in Italy’s case could only come from an electoral law that promises stable government.

Stournaras outlines several options to finance €10bn gap The core debate about Greece’s financing gap takes place in Germany in the middle of its election campaign. German newspapers are extensively discussing the size of the financing gap and how it should be financed. Another haircut is excluded categorically by German politicians, German central bankers and the Greek finance minister. In an interview with Handelblatt, Yannis Stournaras suggested several options to close the gap either by lowering interest rates on existing loans or extending the repayment period. FAZ writes that the Greek government contemplates to tap unused funds from the banking recapitalisation fund, out of €50bn only €39bn have been used so far. For this Stournaras suggested to delegate retroactively the banking rescue to the ESM, something Germany is reluctant to agree to. Mussler says the German debate over Greek aid is misguided Werner Mussler’s excellent comment in the FAZ argues that the whole debate in the German election campaign about whether the Greek finance gap is €10bn, a small double digit number or whether it ‘cannot be known exactly’ is beside the point, as It concerns the financing gap under the existing bailout programme for 2014/2015. It suggests that with a third little programme the whole Greek aid debate is over. But it is not. The financing need for Greece after 2015 are much more substantial. The IMF calculated that Greece will need further debt relief of over 4% and 3.5% of GDP after 2015 to get public debt down to the target of 124% by 2020 and below 110% by 2022. This relies on optimistic growth assumptions so that the amount might end up to be higher. The IMF made it also clear that Europe has to fund this. Neither Angela Merkel nor Peer Steinbruck offer a clear concept here. Greece sends 12000 civil servants into labour mobility scheme Kathimerini reports that Greek authorities signed off on the move of 12,500 civil servants into a so-called mobility scheme by the end of next month. But sources said hurdles remained, partly due to the slow progress of a scheme aimed at evaluating staff. Also there was some hesitation on the political level with PASOK leader Evangelos Venizelos, emphasizing the need for a mobility scheme being dissociated from sector layoffs, which the government has also promised. Troika mission chiefs are expected to seek an update on delayed civil service reforms when they return to Athens at the end of next month, probably after elections in Germany. French government offers cut in labour costs In the first consultation round over the pension reform, Jean Marc Ayrault reassured trade unions and offered the employers organisation MEDEF a reduction in labour costs that could more than compensate for the rise of contributions to finance the pension reform. Les Echos reports that the government currently works on a scenario of €20bn reduction for companies, and a 0.1% increase in contributions shared by employers and employees, which is to raise €700m in 2014 and then €3bn per year until 2020. Ayrault also reassured trade unions that there will be no pension cut nor freeze, that there will be no recalculation of the pension formula until 2020, and reiterated an offer of extra funds to compensate for hardship at work. Le Monde writes that while the government proved to be skilful to search out a consensus in its first day of negotiation, it cannot avoid confrontation on the explosive issues. Hardline CGT union chief Thierry Lepaon, who opposes any lengthening of the pay-in period, said the talks were encouraging but not enough to justify calling off protests which are planned for September 10.

Moody’s pessimistic on Spanish NPLs Moody’s latest analysis on Spain’s banks predicts that the nonperforming loan ratio will continue to rise from the record 11.6% seen in June, reports Europa Press. This is despite Moody’s forecast that Spain’s recession will bottom out in the second half of the year as the economic crisis and persistent high unemployment will continue to feed a “chronic” real estate slump. The agency points out that the nonperforming loan ratio has been affected by the recent regulatory reclassification of refinancing as dubious loans, which increases the reported amount of nonperforming loans, but also by the transfer of assets to the SAREB “bad bank”, which reduces the total amount of bank credit. In addition, Moody’s sees low bank profitability in the future as foreclosures on bad loans result in a lower return on assets and an increase in loan loss provisions. Jenkins on how the banks are preparing for the AQR Patrick Jenkins has a useful article in the FT in which he gives a detailed overview of how the banks are preparing for the ECB’s scheduled asset quality review. The EBC plans on communicating the details of the exercise in October for completion in March, followed by a stress test – the whole idea being to regain credibility after the botched stress tests of recent years. Banks, meanwhile, are preparing. Intesa SanPaolo revealed a 30% increase in provisions for bad loans, citing the AQR as the reason. So did Unicredit. One of the measures the ECB wants to implement is a pan-European definition of non-performing loans, to be defined as anything that is 90 days past due, and to categorise all loans to a single borrower as non-performing if a single loan by that borrower is in distress. The article includes an estimate that these measures could increase NPL’s by some 40% on average, forcing weaker banks to raise capital. Several banks, such as Erste Bank and Raiffeisen in Austria have already increased capital, and the Slovenian government also promised to inject capital into its banking system. The main obstacles are political. The European parliament still has to vote, and there is still disagreement about on the resolution regime. Susanne Holl says no chance for a coalition of the Left in German In an editorial in Suddeutsche, Susanne Holl writes about the scenario in which the German elections resulted in neither a straight win for the current coalition, nor in a win by the SPD and the Greens. In that case, the certain outcome is another grand coalition. Speculation about a coalition between the SPD, the Greens, and the Left Party is completely wild. Peer Steinbruck and Sigmar Gabriel, SPD chairman, are both against it. Even if the SPD had a leader crazy enough to entertain the idea of a coalition with a party that has rejected all euro crisis decisions by the Bundestag, he would lose so much support from within his own ranks that he could not govern. The party’s future would be at risk. The risks association with a coalition that included the Left Party are far more immense than those associated with another grand coalition. There is a debate, including among editorialists in Suddeutsche, about what will happen if the elections were to bring an indecisive result. We agree with Holl only in respect of what is likely to happen – the SPD will not enter into a formal coalition with the Left party, having explicitly ruled out this option before. We are less certain about a minority government. And we disagree with her assertion that the euro crisis separates the parties of the Left. All three parties essentially agree on the causes of the crisis. They disagree on the tactics of how to confront Angela Merkel. But they have more in common with each other than they have with the CDU or the FDP.

Anti-euro party appeals to president Gauck over costs of crisis Claus Hulverscheidt has an interesting article on the latest attempt by Bernd Lucke, head of the anti-euro party AfD, to get the German government to reveal the costs of the euro crisis. Lucke has written to President Joachim Gauck to appeal to Angela Merkel to come clean on the financial burden. Lucke had previously tried unsuccessfully to use freedom of information legislation to force the publication of documents showing alternative cost calculations undertaken by the government. Lucke is convinced that the German government delays the publication of the cost estimates until after the election. His own estimate about the Greek rescue programme is that it will cost the German taxpayer some €50bn. The only calculations the German government has published, or rather leaked, are those concerning alternative scenarios for the eurozone – such a Greek or a German departure – which would be dramatically more expensive than the pursuit of the current policies. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.547 0.563 0.568 Italy 2.404 2.532 2.539 Spain 2.533 2.570 2.618 Portugal 4.660 4.718 4.770 Greece 8.212 8.220 8.24 Ireland 2.076 2.104 2.122 Belgium 0.861 0.881 0.886 Bund Yield 1.931 1.893 1.886

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.337 1.3362

Yen 131.630 131.13

Pound 0.858 0.8589

Swiss Franc 1.235 1.2312

ZC Inflation Swaps

previous last close

1 yr 1.45 1.45

2 yr 1.41 1.41

5 yr 1.52 1.52

10 yr 2 2

Euribor-OIS Spread

previous last close

1 Week -6.643 -6.443

1 Month -2.886 -2.886

3 Months 2.543 3.343

1 Year 28.214 28.414

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-08- 27.html?cHash=30471249218cedc6f7744017d0bcd8a4

Simon Johnson Simon Johnson, a former chief economist of the IMF, is a professor at MIT Sloan, a senior fellow at the Peterson Institute for International Economics, and co-founder of a leading economics blog, The Baseline Scenario. He is the co-author, with James Kwak, of White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You. La tentación de Greenspan 27 August 2013 WASHINGTON, DC – Los redactores de la Constitución de Estados Unidos tuvieron que tomar una decisión fundamental: ¿Debían concentrar el poder en las manos de una persona o diseñar un sistema político en el cual la influencia sobre la toma de decisiones fuese más difusa? Un ejemplo similar enfrenta ahora el presidente de EE. UU., Barack Obama, para seleccionar al sucesor de Ben Bernanke como presidente de la Junta de Gobernadores del Sistema de la Reserva Federal. El legado de Bernanke es decididamente dispar, pero su característica más atractiva es la ética de cooperación profesional y responsabilidad compartida que fomentó en la Fed. De hecho, una meta clave para su sucesor será consolidar ese enfoque como una nueva tradición institucional. Sin embargo, una fuerte inclinación hacia un presidente todopoderoso de la Fed es aparente, tanto desde una lectura de la historia como de los globos de ensayo que la administración de Obama puso recientemente a flotar. La Junta de la Reserva Federal está compuesta por 7 gobernadores; pero, durante la mayor parte de su historia, ha operado a la sombra de sus presidentes, tres de los cuales (Marriner Eccles, William McChesney Martin, y, más recientemente, Alan Greenspan) ocuparon el cargo durante casi 20 años. La política monetaria es, en principio, decidida por el Comité Federal de Mercado Abierto, que incluye a 12 miembros con voto: los 7 gobernadores de la Fed, el presidente de la Fed de Nueva York y cuatro presidentes de los otros 11 bancos regionales de la Reserva Federal (quienes asumen el cargo en forma rotativa por un año). En la práctica, sin embargo, Greenspan y muchos de sus predecesores llegaron a dominar el FOMC. ¿Cuál es el problema con un Presidente omnipotente para la Fed? Comencemos por considerar el duradero impacto de Greenspan, quien creía profundamente que la desregulación financiera contribuiría a un crecimiento económico más estable. Como afirmó en 1997, «A medida que ingresamos al nuevo siglo, las fuerzas regulatorias privadas estabilizadoras del mercado debieran desplazar gradualmente a muchas estructuras gubernamentales engorrosas y cada vez más ineficaces».

Greenspan dejó su cargo en 2006, pero la crisis que pronto se instaló puede atribuirse en gran medida al tipo de innovación financiera que fomentó. Para 2008, en testimonio ante el congreso, Greenspan estuvo dispuesto a aceptar un error fatal en su pensamiento –los mercados financieros desregulados pueden, de hecho, fallar terriblemente. En una situación que exige tomar decisiones rápida y audazmente, alguien debe estar a cargo. El Congreso Continental hizo lo correcto cuando, en 1775, pidió a George Washington que liderase las fuerzas que entonces se sublevaban contra los ingleses. Pero Washington, a su vez, fue sabio al declinar los poderes autoritarios después de la independencia –y, nuevamente, cuando renunció después de ocho años en calidad de primer presidente del nuevo país. El mundo financiero moderno es veloz y complejo. El siguiente presidente tendrá que actuar con decisión para persuadir a sus colegas cuando sea necesario; pero, en primer lugar y lo que es más importante, necesitará una fuerte dosis de humildad y respeto por las percepciones de sus pares. La política monetaria implica un significativo grado de arte, además de cierta ciencia. Y nuestra comprensión de la «regulación macroprudencial» y cómo afecta a la estabilidad financiera aún está en una etapa muy temprana. Las consecuencias de no entender bien las interconexiones entre países han atacado reiteradamente por el lado ciego a los bancos centrales más importantes del mundo –consideren la crisis del euro o la fuerte dependencia de los bancos europeos del financiamiento de los fondos de inversión en mercados de dinero estadounidenses. El próximo presidente de la Fed deberá ser alguien de mente abierta, dispuesto a involucrar al personal y deseoso de cultivar la pericia en todo el Sistema de la Reserva Federal. La peor elección posible sería elegir a alguien que comparta las inclinaciones de Greenspan –restringir los datos, monopolizar la toma de decisiones e intentar intimidar a sus colegas. Un mandato de 20 años para tal persona sería una receta para el desastre económico, que comenzaría, sin duda, con algún tipo de crisis financiera. Pero ése no sería el mayor de los peligros. Habría también insistentes pedidos para restringir los poderes de la Reserva Federal o limitar su independencia del Congreso. Los países han experimentado permitir a los políticos el control de la política monetaria en el día a día. Nunca termina bien –a los políticos siempre les resulta demasiado tentador exprimir la economía camino a una elección o en otros momentos políticamente importantes. En vez de jugar con fuego y proponer un presidente de la Fed que aspiraría a convertirse en una figura dominante, tal vez la administración de Obama debiera considerar un límite de tiempo para ese cargo (digamos, ocho años). Los límites a los períodos mejoran el gobierno en algunas otras agencias oficiales estadounidenses y en otras partes. El problema es que una vez que la reforma de la Fed se ponga sobre la mesa, surgirán todo tipo de ideas. La aleatoriedad del proceso político fácilmente podría generar resultados que reduzcan su independencia. Por esto es tan importante el estilo de liderazgo del presidente de la Fed. Ben Bernanke cometió errores –incluida su forma de pensar excesivamente similar a la de Greenspan rumbo a la catástrofe de 2008. Pero también estableció los rudimentos de

42 un proceso para la toma de decisiones con más cooperación profesional y equilibrio en la Fed. Su sucesor debiera ser elegido para construir sobre este logro. Traducción al español por Leopoldo Gurman. This article is available online at: http://www.project-syndicate.org/commentary/the-federal-reserve-s-leadership- question-by-simon-johnson/spanish

Daily Morning Newsbriefing

August 26, 2013 Towards a third package for Greece Welcome back to Eurointelligence Professional after our summer break. Since our last briefing, a full blown debate about a third aid package for Greece has developed over the last week after Wolfgang Schäuble told a campaign rally that a new rescue for Greece was inevitable. The IMF estimated last month Greece would face a funding gap of nearly €11bn for 2014-2015. The Greek finance minister Yannis Stournaras told Proto Thema newspaper on Sunday that Greece expects to need a further €10bn in extra support, but would not expect any loan to come with conditions attached. "We are not talking about a new bailout but an economic support package without new (austerity) terms...Until 2016 the targets - our obligations - have been set and other measures or targets cannot be required." In Germany, the sensitive issue became a central theme in the election campaign, as expected. Angela Merkel sought to reassure voters on Sunday that Greece would not need a debt write-down but left open the option of more aid. Opposition parties, who have long accused Merkel of hiding from German voters the truth that they will at some point have to pump more money into the euro zone, have seized on the issue. Merkel's SPD rival Peer Steinbruck said he would press her on the issue in coming weeks, including in a television debate in a week's time. "(The government) has handed out sleeping tablets and tried to hush up the fact that the stabilisation of the euro zone will have a cost," Steinbruck told the Sudwest Presse newspaper. Pollsters, however, say while the issue of Greece is dangerous for Merkel, opposition parties may not benefit as they have backed the bailouts in parliament and were in government when Greece entered the monetary union. A third package is also discussed in other creditor countries. The Finnish PM Jyrki Katainen, speaking on national radio, said Greece's lenders would very likely have to help the troubled country to manage its massive debt, possibly by reducing interest rates on bailout loans. "I am not sure (Greece) will need a new bailout, but some kind of debt restructuring is a very high likelihood," Prime Minister Jyrki Katainen said in a radio interview with YLE Radio Suomi. Jeroen Dijsselbloem, meanwhile, was hit by a storm of criticism after admitting that Greece might need another bailout. Opposition parties pounced on the remarks to question why the Netherlands has extra money to fund a Greek bailout while Dutch 43 taxpayers are being asked to make new sacrifices at home. The government ignored calls for a debate and Dijsselbloem later clarified he hadn’t promised Greece will be bailed out again, according to Kathimerini. Greek central government debt rose to €321.6bn at the end of the second quarter from €305.5bn in December. The Greek finance ministry said on Sunday that rise was not a surprise but the result of funds borrowed to recapitalise Greece's top four banks in June to restore their solvency ratios. The debt is offset by shares the Greek state now owns in the recapitalised banks, which it estimates will fetch €17bn. Italy’s government crisis: How real is the PdL’s threat The Italian media have been preoccupied with a meeting by Silvio Berlusconi’s PdL over the weekend, which threatened to pull out of the coalition unless the Senate confirms Silvio Berlusconi’s immunity. A vote is not expected until October – so expect this story to run and run. The PD has threatened earlier that it will vote in favour of the request by the court to withdraw Berlusconi’s immunity, while the PdL predictably seeks to protect its leader by issuing counter-threats. This morning, Paola Di Caro has a thoughtful analysis in Corriere della Sera, in which she writes about the tactics by Silvio Berlusconi’s PdL. She says the party is in a waiting game that is unlikely to be resolved soon. She writes that senior government officials are hopeful that this crisis can be resolved, and in any case there was still some room for manoeuvre. For example, the PdL’s general secretary Angelino Alfano has yet to meet President Giorgio Napolitano to discuss the available political options. She concludes the next obstacle is the still unresolved question over the housing tax IMU – to be discussed by the cabinet this week – an issue that could yet derail the coalition and force elections in September. But if the parties in the Letta coalition manage to overcome this specific dispute, the best strategy for Berlusconi would be to calm things down a bit, and play a waiting game. Rajoy faces claims that he lied to Parliament In the “Bárcenas Case”, allegations have surfaced that Mariano Rajoy made false statements to the Spanish Parliament in the extraordinary plenary session held on August 1, the last day before the Summer recess. Specifically, Rajoy said that “on taking office as PM, Mr. Bárcenas was no longer in the [People's] Party”. Two weeks ago, just days before the three latest PP Secretary Generals testified before the investigative judge as witnesses in the Bárcenas case, El Mundo published an alleged payroll statement showing the PP was paying Bárcenas a monthly salary of over €18k several months after the PP won the latest general election. As a result of this (see El Mundo again), the political opposition have taken the view that Rajoy lied to the Parliament and the PSOE is exploring legal reforms to allow the Parliament to rebuke Rajoy, coming short of impeachment which is not contemplated in the Spanish Constitution. Continuing with its campaign against Rajoy, El Mundo leads this Monday's print edition with an account of how Bárcenas, when he was forced out of the PP as a result of his involvement in the “Gürtel” court investigation, was able to force the dismissal of his deputy and Party Manager Cristóbal Páez. This was allegedly a condition for Bárcenas to give up his PP membership and Treasurer position; however, Bárcenas retained a wage, a secretary and an office at the PP headquarters. El País writes that, in her court statement on August 13, then and current PP Secretary General Dolores de Cospedal claimed to not have been involved in the negotiations with Bárcenas, which were conducted by her predecessor Javier Arenas on behalf of Mariano Rajoy. In addition, the PP announced it will sue the PSOE's 3rd in command, Óscar 44

López, for claiming the PP had “B accounts” and made “B payments”, reports El País. The PSOE's interpretation is that the judge investigating the Gürtel and Bárcenas cases has already ascertained the existence of shadow accounts as well as cash payments. Spain's debt/GDP ratio exceeds 90% as risk premium drops Spain's public debt exceeded 90% of GDP in June, writes El País. This is based on Bank of Spain estimates that debt increased by over €6bn in the month of June. The article recalls that private debt left over from the economic boom years remains at 220% of GDP, while public debt has increased as a result of the now 6 years of economic crisis. Spain has already attained its deficit goal for 2013 in the first half of the year, of 3.8% of GDP. Spain's risk premium is down to 2011 levels. Economist Santiago Niño Becerra, quoted by El Economista, argues that this is due to a market conviction that the Spanish government “will rather close hospitals and schools than default on the debt”. Thus, rises in German bond yields are not being compensated by Spanish yields and the risk premium has dropped to 250bp, from a peak of 637 last year. Spain's biggest retailer continues to lose revenue and profits The depth of the slump in Spain's domestic demand is illustrated by the predicament of El Corte Inglés, the country's largest retailer. The privately-held department store chain reported for 2012 an 18% year-on-year profit drop, to €171m, reports Reuters. Gross revenue also dropped but by only 8%. El País gave a rosier reading of the figures by comparing them with those for 2011, when profit had dropped by 34%. The company had earlier this month negotiated an 8-year maturity extension for €3.5bn or 76% of its bank debt, as reported by Expansión. French “Ras-le-bol” over taxes After a series of announced tax increases, the hostile reactions multiply in France, where the “ras-le-bol” starts to concern the government. The 2014 budget is set for €6bn tax hikes plus the planned rise in VAT rates. The government now looks for new avenues to raise the money other than taxes. Les Echos reports that new 2014 growth forecasts could be used recalculate the need for new tax revenues of below €6bn. An editorial in Le Monde says the government is right to be concerned about taxpayers’ outcry. Also EU Commissioner Olli Rehn warned the French government that tax increases would reduce growth and employment. In an interview with Le Journal du Dimanche Rehn said: budgetary discipline must come from a reduction in public spending and not from new taxes. The FT writes that Rehn’s comment came after the French government announced last week a new green tax designed to encourage businesses and households to reduce energy consumption. Strongly criticised, PM Jean-Marc Ayrault rushed to insure at this weekend that the tax which it said would be part of the 2014 budget proposal, would be fiscally neutral. The interesting part of the story comes from Les Echos, reporting in its top story that the tax debate is about to affect the current pension reform discussions, where the option to raise social contributions is slowly losing its support. The PM will discuss the pension reforms with union leaders today and tomorrow. The final proposal is expected to be presented at a cabinet meeting on September 18.

Irish mortgage arrears get worse Reuters reports from Dublin that the number of households with mortgage arrears has gone up in the second quarter, frustrating expectations that lower unemployment might have brought relief. The number of those in arrears for over 90 days rose from 12.3% in the first quarter to 12.7% in the second, and is now more than double than the start of 2011. The article quoted an analyst as saying that arrears are a backward looking indicator, and that it would take time for the economic recovery to translate into lower arrears. HRE to sell Depfa Der Spiegel magazine has a story this morning that HRE, the nationalised German bank, is looking for a buyer of its real-estate arm Depfa – all part of the German government plans to start its withdrawal from HRE by 2015. The German government also wants to sell Deutsche Pfandbriefbank, the second subsidiary of HRE. By the end of 2012, the official bad assets of HRE were €134bn. German poll sees strengthening of Merkel coalition There has not been much change in the German political polls this month. Here is the latest ZDF Politbarometer. This polls suggests that the present coalition could maintain a waver-thin majority, with 47% versus 46% for SPD, Greens, and the Left combined. CDU/CSU 41% FDP 6% SPD 25% Greens 13% The Left 8% Confidence rises in August The confidence data have been producing a consistent picture of a slow recovery from the recession. The latest is the European Commission’s consumer confidence indicator, which rose from -17.4 in July to -15.6, the highest reading for two years. Earlier last week, the latest eurozone business confidence indicators were also consistent with a picture of a slow but consistent economic recovery. During Q2, eurozone GDP increased by 0.3%, with Germany up 0.7%, but this is a rate that it unlikely to be sustained. The impact of creditor status on interest rates Writing in Frankfurter Allgemeine, Frank Westermann is quoting from his paper with Sven Steinkamp, showing a robust statistical relationship between sovereign bond spreads and the creditor status of the bailout loans. He writes that the eurozone is witnessing a similar situation to Latin America where the interest rates were also largely determined by the credit status of the bondholders. The reason why the OMT has achieved its success, he writes, is that the ECB has given up on its preferred creditor status. But the loss of creditor status by the ECB is not cost-free, especially considering the debt dynamics in the eurozone. These losses will ultimately be incurred. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.559 0.547 0.560

Italy 2.400 2.413 2.419 Spain 2.564 2.533 2.530 Portugal 4.677 4.660 4.662 Greece 8.219 8.212 8.24 Ireland 2.077 2.076 2.073 Belgium 0.883 0.861 0.872 Bund Yield 1.922 1.931 1.925

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.334 1.338

Yen 132.150 131.74

Pound 0.858 0.8591

Swiss Franc 1.235 1.2343

ZC Inflation Swaps

previous last close

1 yr 1.44 1.45

2 yr 1.4 1.41

5 yr 1.65 1.52

10 yr 1.99 2

Euribor-OIS Spread

previous last close

1 Week -6.143 -6.643

1 Month -2.686 -2.886

3 Months 2.743 2.543

1 Year 27.643 28.214

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-08- 26.html?cHash=2982abb0f77401d3c9df4665b7375a84

Introducing ‘The Tuition is Too Damn High’ By Dylan Matthews, Updated: August 26, 2013 “The Tuition is Too Damn High” is a 10-part series that will run in Wonkblog over the next two weeks exploring the causes and consequences of — and potential fixes for — the skyrocketing costs of higher education. This is part one. My mom graduated from college in 1975. Her senior year at the University of Hawaii at Manoa, the state’s flagship campus, cost $322 (around $1,400 today), financed by generous state subsidies. Not only did she graduate with no debt, but she managed to pay her way through college by working part-time. I also worked part-time in college (writing Wonkbook!) but there was no way that was going to pay my tuition. In total, my senior year of college in 2011-2012 cost $36,305 in tuition, or $52,652 including room and board. Sure, I chose a more expensive school than my mom did. But it wasn’t just that. As parents of high schoolers know, college tuition has been skyrocketing in the past few decades.

According to the U.S. Department of Education, the average annual tuition, fees and room and board at a public college or university in 1964-65 — the first year for which there’s data — was $6,592, in 2011 dollars. By 2010-2011, that had increased to $13,297 — a 101.7 percent increase. The increase for private schools was even more dramatic. Average tuition, fees and room and board in 1964-65 was $13,233 a year; in 2010-2011, it was $31,395, an 137.2 percent increase.

That’s after accounting for inflation. But some experts think that the adjustment lets colleges off the hook — after all, the rising price of college tuition is itself a significant driver of inflation. If you don’t adjust for inflation, college tuition prices increased 297 percent from September 1990 to September 2012, according to the Bureau of Labor Statistics. Medical care prices, by contrast, only increased 152 percent. You’d think that such enormous price increases would keep consumers away. You’d be wrong. In 1967, 4.3 million people were enrolled in full-time in colleges and universities as undergraduates, amounting to 2.2 percent of the U.S. population.

About 11.5 million were enrolled full-time in 2010, or about 3.7 percent of the population. That’s a nearly 70 percent increase in college enrollment as a share of the population.

Consumers aren’t being dumb here. They’re being rational. While the upfront price of college was increasing, so were the benefits. The result is that college is pretty much as good a deal today as it was in the past. Michael Greenstone and Adam Looney at the Hamilton Project calculate that the annual returns on investment in a college degree have stayed pretty constant at 15 to 17 percent for the past four decades. For comparison, annual returns are about 6.8 percent for the stock market, 2.9 percent for corporate bonds, 2.3 percent for gold and 0.4 percent for housing. College is a much better investment than any of those, even if you drop out. Those returns don’t include the impact of recent increases in financial aid. Once you take that into account, the returns on a college degree have arguably been growing. That shouldn’t come as a surprise to people following economists’ debates regarding skills and technology. As Harvard economists Claudia Goldin and Lawrence Katz’s book “The Race Between Education and Technology” explains, the demand for highly skilled workers has been rising faster than the supply of late. That has pushed the wage premium for college-educated workers, and thus the returns on a college education, upward. If anything, it’s surprising that the increase in enrollment hasn’t been larger.

But if the upfront price of college is rising much faster than earnings, how are more and more families managing to pay for it? In large part, by going into debt. The total student loan burden now exceeds $1 trillion, with two-thirds of the class of 2011 taking out

50 loans and over 40 percent of 25-year-olds still in student loan debt. About two-thirds of borrowers have debt loads under $25,000, but that means one-third are looking at more than $25,000 in debt. All in all, 17 percent of borrowers are at least 90 days delinquent on their payments. Maybe that’s smart; college is a good investment, as we’ll see in more detail in later segments, and some have even suggested that there might actually be too little student debt. But that debt is a new and major part of our financial world now. It’s a lot of money, be it paid by borrowers, by their parents through savings, by state governments, or by the federal government through everything from Pell Grants to loan guarantees. This series will try to figure out where the money is going, why it’s going there and what can be done about it. Stay tuned. http://www.washingtonpost.com/blogs/wonkblog/wp/2013/08/26/introducing-the- tuition-is-too-damn-high/

ft.com Comment Blogs Gavyn Davies Will the emerging world derail the global recovery? August 25, 2013 5:02 pm by Gavyn Davies The financial markets’ love affair with emerging market assets, which peaked in 2010, has plumbed new depths during August. Emerging market equities (in $ terms) are now down by 12.2 per cent so far this year, while developed market equities have risen by 11.2 per cent. Emerging currencies have been in free fall. As a result, interest rates have been tightening as GDP growth expectations have been persistently marked downwards, which is usually a toxic combination for risk assets. Two major questions arise from these events. First, when will the underperformance of emerging assets, relative to the developed world, hit bottom? Second, and more important, will the near-crisis in the emerging world spill over to the developed world, bringing the nascent recovery in advanced economies to an end? If this were to occur, the bull market in risk assets in the western economies would surely be over. The answer to both of these questions will depend on how serious the emerging market economic slowdown becomes in the next few quarters. The miracle of the BRICs in the 2000s was largely driven by a single colossus, China, with many other emerging economies becoming supplier-economies to its massive appetite for commodity imports. As I have argued here, the workout from the Chinese credit bubble may not develop into a full-blown crisis, but it is likely to be difficult and prolonged. This suggests that the supplier-economies, like Brazil, South Africa and Russia will not enjoy a rapid rebound in growth. Furthermore, China is not the only economy which is suffering from the pain of controlling a credit bubble. Some emerging economies, with Turkey, India and Indonesia prominent among them, have old-fashioned balance of payments crises triggered by expansionary fiscal policy and over-accommodatory monetary policy. The plight of these economies has of course been heightened by the likely tapering of asset purchases by the Fed in September. But it has now become clear that many emerging economies, including China, adopted excessively expansionary fiscal and monetary policy in response to the global financial crisis of 2008, and they are now paying the penalty. It would be surprising if none of them ends in the hands of the IMF, where Christine Lagarde is clearly preparing to help. John Authurs argues that it is too early to go bottom fishing in emerging market assets, and I agree with him. How bad would the emerging economies need to get before they could threaten the health of the developed world? In the past, this has never really been a major issue, since the scale and trading patterns of the emerging world clearly meant that they lagged the cycle in the developed world, with little fear of significant feedback in the other direction.

There was no doubt about which was the dog and which was the tail, even when a major crisis like the 1997 Asian shock erupted in the emerging world. But the Chinese economy, measured in PPP exchange rates, is now similar in size to that of the US and the eurozone, so there is much greater danger that the developed economies will be badly affected by trouble in China.

In order to gauge the risk of a spillover large enough to take down the entire global economy, my Fulcrum colleague Juan Antolin-Diaz has estimated a VAR model which shows how the three largest economies (the US, the eurozone and China) have related to each other in recent years. We have then applied two separate shocks to the system: a downward shock equivalent to 2 per cent of GDP in China, reflecting the work-out from the credit bubble; and an upward shock equivalent to 1.5 per cent of GDP in the US, reflecting the rise in private expenditure and the decline in fiscal tightening expected in the near future [1]. According to the model, this is how the world economy would be affected by these two shocks: The graph shows that the initial impact of these two shocks is to reduce the global growth rate by about 1 percentage point for a couple of quarters, with the impact turning positive about a year later, presumably owing to the easing in macro policy which would follow the initial slowdown. (The central estimate is shown with the red line, with two standard deviation bands shaded in blue.) The model therefore suggests that the kind of shock which is currently underway in China will slow the global growth rate by a modest amount for about a year, but that it will not cause a major global recession, as long as the positive shock in the US actually does materialise as expected. The twin shocks would, however, have a large effect on the distribution of growth between the major three geographical blocks in the global economy. The adverse effect on Chinese growth peaks at -3 per cent, and stays continuously negative for around 18 months.

In the eurozone, the adverse effects of the Chinese shock dominate for a while, but this disappears after a couple of quarters, after which the positive effects of the US boost tend to dominate.

Finally, in the US itself, the GDP benefits stemming from domestic events (with the expansion in private consumption and investment gradually overtaking the effects of fiscal stringency) are almost exactly offset by the Chinese slowdown for about 6 months, but after that the annualised growth in real GDP is boosted by about 1.5 per cent. Conclusion Overall, then, the markets seem to be broadly correct in their assessment of the two significant shocks which are currently hitting the global economy. These are likely to have a marked effect on the relative growth rates of the major regions, with the

54 emerging world being hit while the US gains, but the net effect on the entire global economy may not be very large. The outcome would, however, be different if the size of the shock hitting China were to increase significantly. For example, if the initial shock were to increase by one half, from -2 per cent of GDP to -3 per cent (which would take Chinese GDP growth down into the 5 per cent region for a while), then the overall adverse impact of the two shocks on global GDP growth would peak at about -2 per cent for a couple of quarters. This would probably be enough to threaten a renewed global recession, even assuming that the expansionary shock in the US remained intact. In other words, the emerging market malaise could indeed take the global economy down with it, but only if the Chinese shock turns out to be much larger than currently seems likely. —————————————————————————————— Footnote [1] The simulations shown should be regarded as nothing more than illustrative, both in the overall effects and particularly in the timing of these effects. The size and nature of the feedback effects between shocks in the emerging and developed world may have changed in recent years in ways which have not been identified by this statistical model. http://blogs.ft.com/gavyndavies/2013/08/25/will-the-emerging-world-derail-the-global- recovery/

ft.com World Europe August 23, 2013 5:34 pm German growth figures set to offer election boost to Merkel By Michael Steen in Frankfurt

©AP Angela Merkel Chancellor Angela Merkel received a pre-election boost on Friday, with confirmation that the German economy is steaming ahead less than a month before a poll whose victors will shape Europe’s response to the debt crisis. After a wobble in the final quarter of last year when the economy contracted, Germany just barely returned to growth in the first three months of the year but, driven by private and domestic demand, gross domestic product jumped 0.7 per cent in the second quarter, according to the federal statistics office. On Friday it confirmed its initial estimate of the growth figures and released detailed numbers. Growth at that rate is highly unlikely to be sustained, economists said, with the country likely to settle into more modest growth for the rest of the year as the wider eurozone stages a gradual recovery too. More ON THIS TOPIC// Merkel forced on defensive in TV debate/ Sebastian Dullien Miracle running out of road/ Tony Barber Germany strong, but not strong enough/ Hans-Werner Sinn Wrong to portray Germany as euro winner IN EUROPE// Bale moves to Real for record €100m// Merkel and Steinbrück go head to head// Hollande wrongfooted by US move on Syria// Pope appoints new secretary of state Still the data allow Ms Merkel, seeking re-election on September 22 for her Christian Democratic Union who govern in coalition with the liberal FDP, to go into the fiercest stage of the campaign trumpeting a buoyant economy and no imminent threat of rising unemployment. “The national unemployment rate (at 6.8 per cent) is only slightly above the natural rate of unemployment,” Anna Zabrodzka, economist at Moody’s Analytics, said, adding that this level, below which unemployment cannot fall without stoking inflation, was estimated to be 6.7 per cent. While Germany’s success in keeping unemployment low during the crisis has involved reduced hours and more flexible working practices that have themselves fuelled

56 resentment among some workers, it has been hard for the opposition to land many punches on domestic economic policy. A much greater public concern has been the “bill” faced by German taxpayers for bailing out Greece, Ireland, Portugal, Cyprus and banks in Spain, even though to date the rescues have not led to any losses from the guarantees and loans Berlin made. German business daily Handelsblatt calculates that those total risks amount to about €150bn, although it would take full debt defaults of all bailout countries for that to become an actual cost to taxpayers. Attempting to capitalise on the fear that a big bill is around the corner, the main opposition Social Democratic party stepped up accusations this week that Ms Merkel’s CDU was not telling voters the truth about the risks Germany faced. That led to Wolfgang Schäuble, finance minister, to drop a bombshell on Tuesday by acknowledging for the first time that Greece would need a third bailout, while simultaneously denying there would be any debt forgiveness. The finance ministry and Ms Merkel’s aides spent much of the rest of the week insisting Mr Schäuble had said nothing new and that, in any case, it would be impossible to know before 2014, when Greek progress with its reform programme would be reassessed. A ZDF-Politbarometer opinion poll released on Friday suggested the opposition had made little headway. The CDU and its Bavarian sister party CSU remain on 41 per cent, the SPD on 25 per cent and the FDP has gained a little to 6 per cent, just above the 5 per cent threshold needed to get into parliament. “The government never said the euro rescue would cost nothing,” Mr Schäuble told Handelsblatt in an interview published on Friday. “Until now we have only taken on risks . . . The alternative would be the collapse of the euro. And that would be properly expensive for us.” http://www.ft.com/intl/cms/s/0/9a339d76-0c0a-11e3-8f77- 00144feabdc0.html#axzz2djDkc1ks

August 22, 2013 This Age of Bubbles By PAUL KRUGMAN So, another BRIC hits the wall. Actually, I’ve never much liked the whole “BRIC” — Brazil, Russia, India, and China — concept: Russia, which is basically a petro- economy, doesn’t belong there at all, and there are large differences among the other three. Still, it’s hard to deny that India, Brazil, and a number of other countries are now experiencing similar problems. And those shared problems define the economic crisis du jour. What’s going on? It’s a variant on the same old story: investors loved these economies not wisely but too well, and have now turned on the objects of their former affection. A couple years back, Western investors — discouraged by low returns both in the United States and in the noncrisis nations of Europe — began pouring large sums into emerging markets. Now they’ve reversed course. As a result, India’s rupee and Brazil’s real are plunging, along with Indonesia’s rupiah, the South African rand, the Turkish lira, and more. Does this reversal of fortune pose a major threat to the world economy? I don’t think so (he said with his fingers crossed behind his back). It’s true that investor loss of confidence and the resulting currency plunges caused severe economic crises in much of Asia back in 1997-98. But the crucial point back then was that, in the crisis countries, many businesses had large debts in dollars, so that falling currencies effectively caused their debts to soar, creating widespread financial distress. That problem isn’t completely absent this time around, but it looks much less serious. In fact, count me among those who believe that the biggest threat right now is that policy in emerging markets will overreact — that their central banks will raise interest rates sharply in an attempt to prop up their currencies, which isn’t what they or the rest of the world need right now. Still, even if the news from India and elsewhere isn’t apocalyptic, it’s not the kind of thing you want to hear when the world’s wealthier economies, while doing a bit better than they were a few months ago, are still deeply depressed and struggling to recover. And this latest financial turmoil raises a broader question: Why have we been having so many bubbles? For it’s now clear that the flood of money into emerging markets — which briefly drove Brazil’s currency up by almost 40 percent, a rise that has now been completely reversed — was yet another in the long list of financial bubbles over the past generation. There was the housing bubble, of course. But before that there was the dot-com bubble; before that the Asian bubble of the mid-1990s; before that the commercial real estate bubble of the 1980s. That last bubble, by the way, imposed a huge cost on taxpayers, who had to bail out failed savings-and-loan institutions. The thing is, it wasn’t always thus. The ’50s, the ’60s, even the troubled ’70s, weren’t nearly as bubble-prone. So what changed?

One popular answer involves blaming the Federal Reserve — the loose-money policies of Ben Bernanke and, before him, Alan Greenspan. And it’s certainly true that for the past few years the Fed has tried hard to push down interest rates, both through conventional policies and through unconventional measures like buying long-term bonds. The resulting low rates certainly helped send investors looking for other places to put their money, including emerging markets. But the Fed was only doing its job. It’s supposed to push interest rates down when the economy is depressed and inflation is low. And what about the series of earlier bubbles, which, at this point, reach back a generation? I know that there are some people who believe that the Fed has been keeping interest rates too low, and printing too much money, all along. But interest rates in the ’80s and ’90s were actually high by historical standards, and even during the housing bubble they were within historical norms. Besides, isn’t the sign of excessive money printing supposed to be rising inflation? We’ve had a whole generation of successive bubbles — and inflation is lower than it was at the beginning. O.K., the other obvious culprit is financial deregulation — not just in the United States but around the world, and including the removal of most controls on the international movement of capital. Banks gone wild were at the heart of the commercial real estate bubble of the 1980s and the housing bubble that burst in 2007. Cross-border flows of hot money were at the heart of the Asian crisis of 1997-98 and the crisis now erupting in emerging markets — and were central to the ongoing crisis in Europe, too. In short, the main lesson of this age of bubbles — a lesson that India, Brazil, and others are learning once again — is that when the financial industry is set loose to do its thing, it lurches from crisis to crisis. http://www.nytimes.com/2013/08/23/opinion/krugman-this-age-of- bubbles.html?partner=rssnyt&emc=rss

ft.com Comment Opinion

August 21, 2013 4:50 pm The new Fed chair should not be one of the usual suspects By Edwin Truman The US and the world need someone who will shake up the central bank, says Edwin Truman

©AFP The seal of the Federal Reserve Board of Governors The unusual public debate about whom President Barack Obama should appoint as the next chair of the US Federal Reserve has focused on such issues as gender and the expertise as economists of the various aspirants to guide monetary policy. The former is irrelevant. The latter is less pertinent than usual because the Federal Open Market Committee has already set a course for the next few years. A more relevant question is whether the Fed needs an outsider. The three said to be under consideration – Lawrence Summers, lately an adviser to Mr Obama, Janet Yellen, current Fed vice-chair, and Donald Kohn, a former vice-chair – are all essentially highly competent insiders. But that is not enough to restore the Fed’s credibility. More ON THIS STORY// Roger Altman The Fed needs Summers/ Scott Sumner Summers is the wrong choice for the Fed/ Summers set to face uphill Fed battle/ Philip Stephens Summers or Yellen? Toss a coin/ James Hamilton Why Yellen should lead the Fed ON THIS TOPIC/ Markets Insight Big fall in US equities could mean Yellen is next Fed chairman/ Central banking still a man’s world/ Global Insight Fed succession reopens Democrat wounds/ Academics square up in fight for Fed IN OPINION/ John van Tiggelen Change at the top Down Under/ Bruce Schneier Spooks need new ways to keep secrets/ Nick Clegg London needs HS2 as much as the north/ John Armitt UK needs an infrastructure strategy Under Ben Bernanke, the current chairman, the Fed has demonstrated enormous creativity, energy and action in using its monetary policy tools to address the global financial crisis. But the new chair must convince a sceptical public and its Washington representatives that it has learnt from the crisis. The Fed has not conducted a public self- examination. It should. Where did its practices go off-track before the crisis? This work would need to be broad: only a small portion of its staff of more than 20,000 is engaged in monetary policy. The Fed’s mandate is much broader, covering not just monetary 60 policy but also the stability of the US and global financial and payment systems. All of these issues – and the Fed’s global role – should be reconsidered. This examination must also resolve questions that emerged during the crisis about the Federal Reserve System. For example, what should be the respective roles of the Federal Reserve Board, each of the Reserve Banks, and the combined Federal Open Market Committee in discharging the Fed’s responsibility for financial stability? These divisions may require restructuring the way the system operates. A vigorous appraisal of its past mistakes is essential not only because of the depth of the financial crisis but also because of the Fed’s recently augmented responsibilities for the supervision and regulation of the financial and payment systems. The Fed needs to re- establish its unquestioned accountability and reputation for all-round competence as the protector of stability. This will require a leader who is an agent for change, not someone who was heavily involved in past decisions. Only six men have served as Fed chair since the Treasury-Federal Reserve accord of 1951, which liberated the Fed to run monetary policy independently of the need to finance federal debt at low cost. Some were agents of change. William McChesney Martin, the author of the accord, certainly was when he was appointed by Harry Truman in 1951. Arthur Burns, appointed by Richard Nixon, used his eight years to sweep away the cobwebs of 19 years of largely benign leadership by Martin. The much-maligned G. William Miller was appointed by Jimmy Carter to succeed Burns. In his brief tenure, he introduced greater discipline into day-to-day operations. Under Paul Volcker, Miller’s successor, the Fed not only whipped inflation, it also took major steps in democratising the system – for example, in the broadening representation on the boards of the Federal Reserve banks and in the transparency of financial operations. Alan Greenspan, appointed by Ronald Reagan to succeed Mr Volcker in 1987, stressed continuity as well as improved communication. In most respects, Mr Bernanke, because he was an insider, was more of the same. The Fed has emphasised intellectual and analytical rigour as well as open debate, and shown a willingness to innovate – but in the context of institutional inertia. The next chair of the Fed must be knowledgeable about monetary policy but need not be a monetary expert and need not be an academic. Only two post-accord Fed chairs have had academic credentials. What the US and the world need is a Fed chair who will shake up the institution. They must be an effective manager as well as an intellectual leader who implements a transformation of the Fed as it enters its second century. That person is more likely to be a well-informed outsider than an entrenched insider. The writer is a senior fellow at the Peterson Institute for International Economics and was a division director at the Federal Reserve Board from 1977 to 1998 http://www.ft.com/intl/cms/s/0/49a62320-fec6-11e2-b9b0- 00144feabdc0.html#axzz2e0Uvkkv9

Opinión LA CUARTA PÁGINA Nadie ha ganado en la crisis del euro La imagen de una Alemania que ha salido triunfadora de la tormenta económica es una ilusión a punto de desvanecerse. Las políticas aplicadas bajo su dictado han hecho a Europa, y a su moneda, más vulnerables Jörg Bibow 21 AGO 2013 - 00:00 CET Hoy es una creencia aceptada considerar a Alemania como ganadora en la crisis del euro. La triste verdad es, sin embargo, que el euro aún no ha producido un ganador real, en tanto que las aparentes ganancias de Alemania en la crisis del euro son en gran parte una ilusión a punto de desvanecerse. En última instancia, solamente un básico rediseño de las políticas y las instituciones de la eurozona haría posible crear una unión de verdaderos “euroganadores”. Ofuscada por ideas y creencias mal concebidas —y en contra de sus intereses nacionales—, Alemania está impidiendo con firmeza que se pueda dar ese paso. Las políticas aplicadas y las reformas emprendidas desde 2009 bajo dictado alemán han hecho a Europa más vulnerable y son, también cada vez más, una amenaza para la estabilidad global. Por de pronto, el euro sigue firmemente la senda de su liquidación, un acontecimiento en el que Alemania se encontraría entre los mayores perdedores. La visión de Alemania como ganadora en la crisis del euro ofrece como prueba el bajo índice de desempleo actual, un presupuesto público equilibrado y unos bajos costes de endeudamiento. El contraste con la situación en cualquier otro país de la eurozona es tan extremo que Alemania también disfruta de una afluencia de inmigrantes cualificados que fortalecen la economía y el mercado de la vivienda. Sin embargo, la situación de la economía alemana está lejos de ser estelar y el hecho de que su superior desempeño actual en términos relativos se haya producido en gran medida a expensas de sus socios en el euro debería provocar alarma más que asombro. La esperanza de vida del euro siempre ha dependido de la convergencia en el seno de la unión monetaria. En vez de ello, las persistentes divergencias y el aumento de desequilibrios no solo han originado la crisis en curso, sino también la ilusión de que Alemania, su aparente ganadora, lo tiene que haber hecho todo bien y debería ser ahora el incuestionable modelo. Pero considerar a Alemania como el “euroejemplo” es una grave tergiversación de los acontecimientos. No solo porque el actual rendimiento de Alemania debiera contemplarse con una perspectiva más amplia: bajo el euro, Alemania ha crecido a un índice medio de poco más del 1% anual; no es muy impresionante. Tiene que entenderse también que Alemania no puede ser el modelo, porque precisamente la factibilidad del modelo alemán depende de que los demás se comporten de un modo diferente. Está en la esencia del modelo de crecimiento de Alemania, cuyo fundamento es la exportación, presuponer unos importadores dispuestos a ejercer de tales.

Estados Unidos, no el mercantilismo alemán, ofrece las pautas adecuadas para la UE

Profundamente arraigado en el sistema de creencias político-económicas del país y en su preciada “cultura de la estabilidad”, el mantra del Bundesbank sostiene que la estabilidad de precios es la causa del crecimiento. Es verdad que el mantenimiento de la

62 estabilidad de precios funcionó bien tanto para Alemania como para el Bundesbank en tiempos anteriores al euro, cuando los socios comerciales estaban inmersos en un sistema estable de tipos de cambio nominal. En esas condiciones, mantener la inflación más baja que la de sus socios comerciales clave impulsaba la competitividad de Alemania y lubricaba su motor exportador. Con el Bundesbank manteniendo a raya la política fiscal y a los sindicatos, el modelo funcionó bien bajo el régimen de Bretton Woods de vinculación global con el dólar. Luego se reavivó a escala regional en la década de los ochenta, con el Sistema Monetario Europeo. La tardía revaluación del marco alemán pudo restaurar temporalmente la balanza comercial, pero solo para iniciar una nueva ronda de creciente competitividad alemana mediante una relativa estabilidad de precios, con una Alemania que basaba su crecimiento en el gasto excesivo de sus socios comerciales. La unión monetaria de Europa fue un compromiso conjunto para mantener la inflación bajo el 2% en toda la zona, como un factor transformador. Por desgracia, las autoridades alemanas no entendieron la esencial realidad de que exportar a Europa el modelo alemán a través del régimen de la Unión Económica y Monetaria (EMU) establecido en Maastricht iba a debilitar su funcionamiento doméstico. Un modelo cuya factibilidad depende de que los demás se comporten de modo diferente no puede pretenderse que funcione forzando a cada uno de ellos a comportarse como Alemania. El respeto general por la histórica norma de estabilidad de Alemania supondría poner un palo en la rueda del tradicional motor exportador del país. Cuando, en los años noventa, ese motor exportador no pudo dirigir la economía al modo habitual, Alemania se embarcó en la restricción salarial para “restaurar” la competitividad. Un desempleo masivo, del que se culpó en gran medida a la unificación, pareció suministrar una excusa perfecta. Las “reformas de Hartz” de la pasada década fueron la etapa final de un viaje que vio a los costes laborales unitarios alemanes apartarse, en dirección descendente, de la norma de estabilidad acordada, preparando el terreno para la actual crisis del euro. La persistente restricción salarial unida a la incondicional austeridad fiscal en nombre de la estabilidad y el crecimiento le valieron a Alemania el título de “enfermo del euro” en la década pasada. Todavía peor, a medida que Alemania estaba cada vez más enferma, se fue debilitando la “única” política monetaria del Banco Central Europeo. Pues en una unión monetaria “la misma talla tiene que irle bien a todos”, presuponiendo condiciones similares. Acostumbrada a encajar en la media regional, la política monetaria se convirtió en demasiado agobiante para Alemania, pero demasiado relajada para los otros países del euro, alimentando burbujas en los mercados inmobiliarios de la periferia de la eurozona. Mientras los precios inmobiliarios se hundían en Alemania, las burbujas financieras que crecían por otras partes crearon el exceso de gasto que Alemania necesitaba para encender su motor exportador.

La factibilidad del modelo alemán depende de que los demás se comporten de un modo diferente

Antes de la crisis, el creciente desequilibrio externo alemán tuvo su contrapartida en buena parte de Europa. Ello dejó a Alemania en una posición muy vulnerable frente a sus excesivamente gastadores socios europeos, tanto en términos comerciales como financieros. Pues las finanzas alemanas también patrocinaban el boom del crédito en los países de la crisis del euro, a través de la generosa refinanciación de bancos en España e Irlanda, por ejemplo.

Los exuberantes flujos de crédito privado finalizaron con la crisis del euro. El crédito oficial y el balance del BCE acudieron al rescate, pero solo añadiendo más deuda a la carga de los países ya en apuros. Alemania solamente puede satisfacer su aparente deseo de permanentes superávits comerciales mediante transferencias fiscales. Resulta irónico que el mercantilismo alemán haya hecho inevitable una transfer union, cuando algo así es lo que más teme el país. Alemania no quiere admitirlo, y hasta ahora la crisis del euro ha proporcionado dos importantes beneficios al país: unos tipos de interés ultrabajos debido a su estatus de refugio y un tipo de cambio del euro mucho más débil de lo que requeriría el balance comercial de su economía. Pero las bazas exteriores de Alemania le suponen quedar enormemente expuesta a sus socios europeos. Una quiebra del euro provocaría masivas pérdidas de riqueza en el país, junto con un emergente nuevo deutschmark que paralizaría el motor de la exportación alemana. Con tanto que ganar impidiendo la definitiva calamidad del euro, ¿cómo se puede sacar al liderazgo alemán de su trampa intelectual? Al igual que la deflación salarial y la absurda austeridad fiscal hicieron enfermar a Alemania en la década de 2000, estamos observando hoy una ciega repetición de esa experiencia por toda la unión monetaria. El parasitismo de Alemania con respecto a la demanda externa proporcionó los antecedentes de la actual e irresuelta crisis del euro. El estado de la economía global parece incapaz de soportar un esfuerzo similar por parte de una Europa germanizada. La unión monetaria de Europa tiene que empezar a gestionar —en lugar de asfixiar— la demanda interna. Estados Unidos, no el mercantilismo alemán, ofrece el modelo adecuado para Europa. Sus políticas y sus instituciones tienen que ser reformadas en consecuencia. Jörg Bibow es catedrático de Economía en el Skidmore College en Nueva York. Texto publicado originalmente en www.e-ir.info Traducción de Juan Ramón Azaol Chttp://elpais.com/elpais/2013/08/15/opinion/1376575328_764583.htmlONVERSA BLE ECONOMIST

Opinión LA CUARTA PÁGINA Cuando las élites fracasan El Gobierno alemán puede cometer un error histórico si sigue defendiendo políticas de corto alcance que lo favorecen en casa en vez de enfrentarse a los problemas que han puesto a Europa en situación de emergencia Jürgen Habermas 20 AGO 2013 - 00:01 CET

ENRIQUE FLORES Con el título, tan significativo, de “Kein deutsches Europa!” [No queremos una Europa alemana], Wolfgang Schäuble desmentía hace poco en un artículo publicado simultáneamente en diarios de Inglaterra, Francia, Polonia, Italia y España, que Alemania aspire a asumir el liderazgo político en la Unión Europea (Süddeutsche Zeitung 20/21 de julio de 2013). Schäuble que, junto con la ministra de Trabajo, es el último “europeo” de corte germano-occidental que queda en el gabinete de Angela Merkel, habla desde el pleno convencimiento personal. Es cualquier cosa menos un revisionista que quiera anular la integración de Alemania en Europa y destruir así el fundamento de la estabilidad del orden de posguerra. Conoce el problema cuyo regreso debemos temer nosotros, los alemanes.

Tras la fundación del imperio en el año 1871, Alemania había adoptado una funesta posición semihegemónica en Europa, tal como expresa la famosa frase de Ludwig Dehio, “demasiado débil para dominar el continente pero demasiado fuerte para integrarse”. Y esto también contribuyó a allanar el camino hacia las catástrofes del siglo XX. La lograda unificación europea impidió, no solo a la Alemania dividida sino también a la Alemania reunificada, volver a caer en el antiguo dilema. Es evidente que la República Federal está interesada en que esto no cambie. Pero ¿no ha cambiado de hecho la situación? Wolfgang Schäuble reacciona ante un peligro actual. Él mismo es quien impone a la fuerza el testarudo rumbo de Angelika Merkel en Bruselas y quien palpa la grieta que podría resquebrajar el núcleo de Europa.

Es Wolfgang Schäuble quien impone a la fuerza el testarudo rumbo de Merkel en Bruselas y quien palpa la grieta que podría resquebrajar el núcleo de Europa

Él es quien tropieza con la resistencia de los “países receptores” en los círculos de los ministros de Hacienda de la comunidad monetaria europea cada vez que bloquea los intentos de introducir un cambio de política. El impedir una unión bancaria para la asunción comunitaria de los costes de la liquidación de los bancos malos es tan solo el ejemplo más reciente de ello. Schäuble no se aparta ni un milímetro de la norma de la canciller de no cargar a los contribuyentes alemanes con nada que rebase el alcance exacto de los créditos que requieran en cada caso los mercados financieros para el rescate del euro, y que siempre han recibido como consecuencia de una “política de rescate” indisimuladamente favorable a los inversores. Por supuesto, este rumbo seguido tan tenazmente no excluye un gesto de 100 millones en créditos para las clases medias que el tío rico berlinés toma de la caja fuerte del banco nacional para sacar del apuro a los primos de Atenas que se han quedado sin blanca. La potencia líder que se niega a sí misma Es un hecho que el gobierno de Merkel obliga a Francia y a los “países del Sur” a aceptar su controvertida agenda de crisis mientras que la política de adquisiciones del BCE brinda un respaldo no admitido. Pero al mismo tiempo, Alemania niega su responsabilidad en el marco de una Europa global por las consecuencias desastrosas que asume al poner en práctica ese papel – considerado como algo enteramente normal - de política de poder. Solo hay que pensar en el exorbitante paro juvenil del sur de Europa como una de las consecuencias de una política de ahorro con cargo a los miembros más débiles de la sociedad. Visto de este modo, el mensaje “nada de Europa alemana” cobra también el sentido, bastante menos bonito, de que la República Federal se coloca en un segundo plano. Desde un punto de vista formal, el Consejo Europeo decide de forma unánime. Angelika (sic) Merkel solo puede perseguir abiertamente intereses nacionales, o lo que ella considera como tales, como uno de los 17 miembros integrantes. El Gobierno alemán saca ventaja, incluso una ventaja desproporcionada, de la preponderancia económica del país siempre y cuando sus socios no duden de la lealtad, carente de ambiciones políticas, de los alemanes hacia Europa. Pero ¿cómo puede resultar creíble este gesto de humildad a la vista de una política que se aprovecha descaradamente de la propia preponderancia económica y demográfica? Cuando, por ejemplo, toca imponer normas de emisión de gases más estrictas para el nuevo rico que fanfarronea de sus berlinas de lujo y estas normas perjudican – por supuesto, siempre en el marco del cambio energético – a la industria automovilística alemana, la votación se retrasa, por intervención de la canciller, hasta que el grupo de presión está satisfecho o ya han pasado las elecciones al Bundestag [Parlamento]. El

66 artículo de Schäuble responde, me parece a mí, a la irritación que este doble juego del Gobierno federal produce en los círculos de los jefes de Gobierno de los restantes países del euro.

El Gobierno alemán saca ventaja, incluso una ventaja desproporcionada, siempre y cuando sus socios no duden de la lealtad de los alemanes hacia Europa

Un Gobierno federal cada vez más aislado trata de imponer frente a Francia y a los países en crisis una dura política de ahorro en nombre de imperativos de mercado que supuestamente no dejan otra alternativa. En contra de los hechos, da por sentado que todos los estados miembros de la Comunidad Monetaria Europea pueden decidir por sí mismos sobre sus respectivas políticas económicas y presupuestarias. Si es necesario deberán “modernizar” el Estado y la economía y aumentar su competitividad con ayuda de créditos del fondo de rescate, pero siempre por cuenta propia. Esta soberanía ficticia es cómoda para la República Federal porque ahorra al socio más fuerte tener en consideración los efectos negativos que pueden acarrear sus propias políticas a los socios más débiles. Por el contrario, Mario Draghi ya advertía hace un año “que no es legítimo ni soportable desde un punto de vista económico que la política económica de países concretos entrañe riesgos que rebasen las propias fronteras y afecten a los restantes socios de la unión monetaria” (Die Zeit 30 de agosto de 2012). ¿Ha caído Europa en una trampa sin salida? Hay que repetirlo una y otra vez: las condiciones poco óptimas en las que la Comunidad Monetaria Europea opera hoy día se deben al error de construcción de una Unión Política que no es plena. Por eso la clave no está en cargar los problemas sobre los hombros de los países en crisis a través de la financiación crediticia. La imposición de políticas de ahorro no puede eliminar los desequilibrios económicos existentes dentro de la zona euro. Solo se puede esperar una equiparación de estas diferencias de nivel a medio plazo como resultado de una política fiscal, económica y social común o en estrecha sintonía recíproca. Y si no se quiere derivar por completo en una tecnocracia al seguir este camino, hay que preguntar a los ciudadanos de los países europeos cómo conciben el núcleo de una Europa democrática. Wolfgang Schäuble lo sabe. Lo dice también en entrevistas concedidas a la revista Spiegel, entrevistas que no tienen consecuencias por lo que respecta a su propia actuación política. La política europea ha caído en una trampa que Claus Offe define con precisión: si no queremos abandonar la unión monetaria, resulta, por un lado necesario y por otro impopular, llevar a cabo una reforma institucional que necesita tiempo. Por eso los políticos que desean ser reelegidos van dejando el problema para más adelante. Este dilema afecta sobre todo al Gobierno alemán, pues hace mucho que asumió con sus actos responsabilidades en el marco de una Europa global. Además, es el único que puede plantear una iniciativa prometedora para dar un paso hacia adelante, debiendo ganarse para ello a Francia. No se trata de bagatelas, sino de un proyecto en el que los hombres de Estado europeos más destacados llevan invirtiendo sus mejores energías desde hace más de medio siglo.

La política europea ha caído en una trampa: si no queremos abandonar la unión monetaria, resulta necesaria una reforma institucional que necesita tiempo

Pero, por otro lado, ¿qué significa realmente “impopular”? Si una solución política es razonable, no debe suponer el menor problema plantearla al electorado de una 67 democracia. ¿Y cuándo hacerlo si no es antes de unas elecciones al Bundestag? Cualquier otra opción supone un encubrimiento tutelar. Infravalorar y exigir demasiado poco a los electores constituye siempre un error. Creo que será un fracaso histórico de las élites políticas de Alemania el seguir cerrando los ojos y hacer como si el business as usual, es decir, el forcejeo corto de miras sobre la letra pequeña a puerta cerrada, fuera la respuesta a la situación del momento. En lugar de eso, deberían hablar claramente a sus ciudadanos, que se sienten inquietos y que jamás se ven confrontados como electores con cuestiones europeas de peso. Deberían pasar a la ofensiva y dirigir un debate, que implica una polarización inevitable, sobre alternativas que siempre tienen un coste. Tampoco deberían callar por más tiempo los negativos efectos redistributivos que deberán asumir a medio y corto plazo los “países donadores” como resultado de la única solución constructiva de la crisis, aunque ello redundará en su propio interés a largo plazo. Vacío normativo Conocemos la respuesta de Angela Merkel: tranquilo quehacer dilatorio. Su persona pública parece carecer de todo núcleo normativo. Desde la irrupción de la crisis griega en mayo de 2010 y el posterior fracaso en las elecciones al Parlamento de la región de Renania del Norte-Westfalia, somete cada uno de sus meditados pasos al oportunismo de la conservación del poder. Desde entonces, la astuta canciller sale adelante con una lógica clara, pero sin unos principios definidos y por segunda vez aleja cualquier tema controvertido de las elecciones al Bundestag, por no hablar de la política europea, minuciosamente aislada. Puede definir la agenda porque, si la oposición se apresura con el tema europeo, de gran carga emocional, es de temer que acabe siendo machacada con la maza de la "unión de la deuda". Y además, por obra de aquellos que solo podrían decir lo mismo si realmente llegaran a decir algo. Europa se encuentra en situación de emergencia y el poder político está en manos de quien decide qué temas pueden llegar a la opinión pública. Alemania no baila, sino que dormita sobre el volcán.

Europa se encuentra en situación de emergencia y el poder político está en manos de quien decide qué temas pueden llegar a la opinión pública

¿Fracaso de las élites? Todo país democrático tiene los políticos que se merece. Y esperar de los políticos que han sido votados un comportamiento que vaya más allá de la rutina resulta un tanto peculiar. Me alegro de vivir desde 1945 en un país que no necesita héroes. Tampoco creo en el dicho de que los individuos hacen la historia, al menos no por lo general. Solo constato que existen situaciones extraordinarias en las que la capacidad perceptiva y la fantasía, el valor y la disposición a asumir responsabilidades de los individuos que actúan marcan la diferencia en el curso de los acontecimientos. Jürgen Habermas es filósofo alemán, ganador del Premio Príncipe de Asturias de Ciencias Sociales 2003. La editorial Suhrkamp acaba de publicar el último volumen de sus Kleinen Politischen Schriften (Breves Escritos Políticos), Im Sog der Technokratie (Arrastrados por la tecnocracia). © 32/2013, Der Spiegel. Traducción de News Clips. http://elpais.com/elpais/2013/08/13/opinion/1376411438_682870.html

Making Do With Less: Working Harder During Recessions by Edward P. Lazear, Kathryn L. Shaw, Christopher Stanton - #19328 (LS) Abstract: There are two obvious possibilities that can account for the rise in productivity during recent recessions. The first is that the decline in the workforce was not random, and that the average worker was of higher quality during the recession than in the preceding period. The second is that each worker produced more while holding worker quality constant. We call the second effect, "making do with less," that is, getting more effort from fewer workers. Using data spanning June 2006 to May 2010 on individual worker productivity from a large firm, it is possible to measure the increase in productivity due to effort and sorting. For this firm, the second effect--that workers' effort increases-- dominates the first effect--that the composition of the workforce differs over the usiness cycle. http://papers.nber.org/papers/W19328?utm_campaign=ntw&utm_medium=email&utm_ source=ntw Happiness, Behavioral Economics, and Public Policy by Arik Levinson - #19329 (EEE PE) Abstract: The economics of "happiness" shares a feature with behavioral economics that raises questions about its usefulness in public policy analysis. What happiness economists call "habituation" refers to the fact that people's reported well-being reverts to a base level, even after major life events such as a disabling injury or winning the lottery. What behavioral economists call "projection bias" refers to the fact that people systematically mistake current circumstances for permanence, buying too much food if shopping while hungry for example. Habituation means happiness does not react to long-term changes, and projection bias means happiness over-reacts to temporary changes. I demonstrate this outcome by combining responses to happiness questions with information about air quality and weather on the day and in the place where those questions were asked. The current day's air quality affects happiness while the local annual average does not. Interpreted literally, either the value of air quality is not measurable using the happiness approach or air quality has no value. Interpreted more generously, projection bias saves happiness economics from habituation, enabling its use in public policy. http://papers.nber.org/papers/W19329?utm_campaign=ntw&utm_medium=email&utm_ source=ntw

The Role of Agents and Brokers in the Market for Health Insurance by Pinar Karaca-Mandic, Roger Feldman, Peter Graven - #19342 (HC IO) Abstract: Health insurance markets in the United States are characterized by imperfect information, complex products, and substantial search frictions. Insurance agents and brokers play a significant role in helping employers navigate these problems. However, little is known about the relation between the structure of the agent/broker market and access and affordability of insurance. This paper aims to fill this gap by investigating the influence of agents/brokers on health insurance decisions of small firms, which are particularly vulnerable to problems of financing health insurance. Using a unique membership database from the National Association of Health Underwriters together with a nationally representative survey of employers, we find that small firms in more competitive agent/broker markets are more likely to offer health insurance and at lower premiums. Moreover, premiums are less dispersed in more competitive agent/broker markets. http://papers.nber.org/papers/W19342?utm_campaign=ntw&utm_medium=email&utm_ source=ntw

Janet Yellen called the housing bust and has been mostly right on jobs. Does she have what it takes to lead the Fed? By Neil Irwin and Ylan Q. Mui, Updated: August 16, 2013 When Janet Yellen jumped from academia to the Federal Reserve Board, she seemed like a new breed at the buttoned-up central bank — eating lunch with staff in the cafeteria and debating ideas like she was back in the faculty lounge. Nearly two decades later, Yellen still carries the air of a scholar, applying a rigorous theoretical approach to America’s economic challenges, particularly unemployment. She is less experienced in the fast-moving world of high finance, or making knife’s edge decisions in the midst of a crisis. Yellen, now the No. 2 at the central bank, has emerged as one of the administration’s top candidates to replace Ben Bernanke as America’s economist-in-chief, and would be the first woman to chair the Federal Reserve. President Obama’s choice — which appears likely to be between Yellen and combative former Treasury secretary Larry Summers — will determine what set of skills will guide the U.S. economy out of its unexpectedly long slump and grapple with whatever nasty surprises lurk along the way. In interviews with more than a dozen people who have worked closely with Yellen, the portrait that emerges is of a careful and deliberate thinker who has been mostly right in her assessments over the tumultuous past six years of crisis, recession and grinding recovery. She has been a strong intellectual force within the Fed, a tough taskmaster for staff and single-minded in her desire to push down joblessness. She has been less inclined to wring her hands over the risks that the Fed’s easy money policies could create new bubbles or stoke inflation. If Obama appoints her to the top job, the open question is not what her approach will be to guiding the nation’s monetary policies; she has given detailed speeches explaining what she envisions for U.S. interest rate policies over the years ahead. Rather, it is how she would adapt to a role in which she is the person in charge. A focus on unemployment Janet Louise Yellen was born in 1946 and grew up in Brooklyn before studying at Brown University and then for an economics PhD at Yale. During an early stint as a Fed staffer, she met another young economist, George Akerlof, who would become her husband, frequent professional collaborator, and eventually a Nobel prize winner. At the University of California-Berkeley, Yellen studied the crucial question of why labor markets don’t work like other types of markets. In particular, she looked at why, in a recession, people go without work rather than take a lower wage — of particular interest in the past few years of high unemployment.

In 1994, Yellen — who declined to comment for the record for this article — was recruited by Clinton administration adviser Laura D’Andrea Tyson to come to Washington as one of seven Federal Reserve governors. “She was not afraid of saying what she thought and why she thought it,” said Alice Rivlin, who served during that era as the Fed’s vice chair. “She was an intellectual leader on the board.” Early in Yellen’s tenure, a debate was emerging on whether the Fed ought to adopt an annual inflation target, like 2 or 3 percent. To air the issue, Chairman Alan Greenspan decided to hold a debate in a closed-door session of the Fed’s policy committee: Al Broaddus, the president of the Federal Reserve Bank of Richmond, would argue for inflation targeting, while Yellen would argue against.Yellen and Broaddus managed to reach some consensus on how they would tackle the issue, but Greenspan froze the discussion. It was a position Yellen would find herself in more than once in Washington: She might have an influential voice, but others made the final decisions. Similarly, Larry Meyer, who served as a Fed governor with Yellen, has recounted a story in which the two of them decided that the Fed needed to raise interest rates to stop the risk of inflation. They went to Greenspan to present their case, threatening to openly dissent if he did not steer policy that way. “He listened, more or less patiently,” Meyer wrote later. “I recall, though this may have not been the case, that he just smiled and didn’t say a word. After an awkward silence, we said our good-byes. Needless to say, we didn’t win this argument.” Yellen’s term at the Fed elevated her profile and caught the attention of the Clinton White House, where she became chairman of the Council of Economic Advisers in 1997.She often argued for market-based solutions to political problems. When Clinton’s environmental advisers wanted the country to join Europe in setting aggressive pollution reduction targets, Yellen worried the move would harm the manufacturing industry and threaten the country’s economic progress, according to those involved in the negotiations. Instead, she pushed to establish a system that would allow companies to trade carbon credits – a requirement that nearly doomed the talks. But Yellen held firm with the support of the man who is now her chief rival — Larry Summers, then the deputy Treasury secretary. “There was no daylight between them,” said Stuart Eizenstat, who was an undersecretary at the State Department at the time. Clinton administration colleagues described Yellen as a thoughtful contributor to debates, but said that the structure of the job meant she would often be on the losing end of internal arguments. The CEA is meant to provide the president with the best advice the economics profession can offer, even when that advice is politically infeasible. It is instead the National Economic Council, headed then and now by Gene Sperling, that typically weighs economic arguments against political concerns and practical realities.“It’s inevitable in a sense that the CEA will not always take the position of other agencies,” said Laura D’Andrea Tyson, who served as both CEA and NEC director. “It’s just the nature of the deal.” The San Francisco Fed and the housing bubble

Yellen returned to Berkeley in 1999, then re-entered public service in 2004 as president of the Federal Reserve Bank of San Francisco, just as the housing market in California and other western states were entering a full-scale bubble. Yellen’s economic training made her suspicious early on that the good times could not last, and she directed the bank’s research staff to drill deeper into the data: What could happen when teaser interest rates on new-fangled mortgages reset? What would become of the piggyback loans many homeowners had taken out on top of their mortgages? How leveraged had Americans become? “Janet was very much a person who asks very probing questions, wants to understand kind of what’s below the conclusions,” said John Williams, who was head of research under Yellen and followed her as president of the San Francisco Fed. So when the leaders of the Fed gathered around their big mahogany table overlooking the National Mall on Dec. 11, 2007, Yellen was perhaps the most gloomy. “The possibilities of a credit crunch developing and of the economy slipping into recession seem all too real,” she said, reading carefully measured words from a sheet of paper. The “shadow banking system,” the complex financial markets that funnels credit to Americans, was freezing up, she said, and the economy was likely to slow significantly. As it turns out, the Great Recession was beginning that very month.But while Yellen voiced one of the most prescient diagnoses of the looming crisis, her position on the West Coast left her little role in sculpting the response. The morning after her remarks, she was back in San Francisco and the Fed was unveiling a complex new set of programs to pump billions of dollars into the global banking system to ease the very freeze-up Yellen had described. They had been engineered by Bernanke’s key lieutenants in Washington and New York, who had spent weeks working through technical challenges and delicate international diplomacy to make them happen. “She was perceptive about the problems in the housing industry but she did not have a major role in the crisis,” said Allan Meltzer, a Carnegie Mellon professor and leading historian of the Fed. Yellen also had little background in regulating banks, though her 1,500 employees in San Francisco were charged with the day-to-day supervision of hundreds of banks in the western United States. That would soon become an important part of her job. “She was very involved, very engaged, and very much wanting to be sure that we were well positioned in the event that there was a change in economic circumstances, given that times had been as robust as they were for as long as they were,” said Stephen M. Hoffman, who was the vice president in charge of bank regulation under Yellen in San Francisco and now is a managing director at Promontory Financial Services Group. There were dozens of bank failures in the states regulated by the San Francisco Fed from 2008 to 2012 — though the most dramatic failures in the region, Washington Mutual and IndyMac, were thrifts that were not regulated by the Fed. Wells Fargo, the largest bank regulated by the San Francisco Fed, weathered the crisis better than other mega-banks, accepting government bailout money grudgingly and repaying it as quickly as possible. A different type of vice-chair

Obama appointed Yellen to become the Fed’s vice-chair in 2010, and she quickly took on a different role in that job than her two predecessors, Donald Kohn and Roger Ferguson (both now dark-horse candidates for the chairman job, as it happens). Kohn and Ferguson acted as trusted deputies,helping Bernanke and Greenspan manage the sprawling Fed system and its varied responsibilities. Both Kohn and Ferguson would often meet privately with the chair and help carry out his priorities: Calling a recalcitrant regional bank president before a policy meeting to push the chairman’s preferred monetary policy; conveying a delicate message to another bank regulator; or solving a personality dispute among the Fed board’s 2,000-person staff. Yellen, by contrast, has acted more as an independent force within the institution. She has also avoided representing the Fed in the political fray, and has not testified before Congress once in her three years as vice-chair. Kohn testified six times in his last three years in the job. And Yellen has spent the past three years trying to persuade Bernanke and the rest of the committee to adopt her preferred course for monetary policy, advocating more aggressive steps to pump money into the economy to bring down unemployment. Traditionally, all seven governors rely on the same staff members for support in conducting research or writing a speech. Yellen, by contrast, built a small group of loyal staffers who worked primarily for her, including one economist, Andrew Levin, whom Fed insiders described as functioning for a time as her de facto chief of staff. Yellen has had an often tense relationship with Daniel Tarullo, the Fed governor who has primary responsibility over bank regulation. Their differences are not so much about policy –both have tended to favor aggressive bank regulation and aggressive low interest rates –but instead are personal and stylistic. “They both have in their own way big egos and big personalities,” said one official who has worked with both. Tarullo was an Obama campaign adviser who was the president’s first appointment to the Fed, and has remained close with former colleagues in the White House. One thing that hasn’t changed from her earlier days as an academic and Fed governor: Yellen still always does her homework. Where Bernanke comes to the Fed’s policy committee eight times a year and speaks extemporaneously from a couple of bullet points, Yellen drafts scripts of exactly what she will say, people who have been in the room said, and reads them word for word. http://www.washingtonpost.com/blogs/wonkblog/wp/2013/08/16/janet-yellen-called- the-housing-bust-and-has-been-mostly-right-on-jobs-does-she-have-what-it-takes-to- lead-the-fed/

Opinión TRIBUNA La eurozona necesita un milagro alemán Guntram B. Wolff 12 AGO 2013 - 00:00 CET Recientemente, un buen número de indicadores positivos sugiere que la recesión en la eurozona está llegando a su final. El indicador de confianza económica (ESI) de la Comisión Europea subió del 91,3 al 92,5 y el clima de negocios también mejoró en julio. Incluso en países que todavía pasan por graves dificultades, como Portugal, el clima de negocios ha mejorado en julio. En España el PIB bajó en “solo” un 0,1% en el segundo trimestre, mientras el ESI muestra una lenta pero continua mejoría durante los 12 últimos meses, alcanzando el 93,5. Para Italia la confianza es de 89,5, casi 3 puntos sobre la medición de junio, y para Francia los indicadores de confianza han sido bastante estables, en torno a 89, durante el pasado año. Finalmente, en Alemania el ESI se sitúa en 100,5. ¿Sugiere todo ello que la crisis está cerca de ser superada? En absoluto; yo no cantaría victoria y, por el contrario, mantengo que son necesarias más actuaciones políticas. El crecimiento económico en la eurozona en su conjunto es todavía débil, con un pronóstico de aumento del PIB para el año próximo de la Comisión Europea que alcanzará el 1,2%. Ello significaría el fin de la recesión, pero el crecimiento sería todavía demasiado débil como para poder impulsar un aumento del empleo. De modo que el desempleo seguirá siendo inaceptablemente alto en la eurozona; de hecho está previsto que descienda solamente un 0,1 de puntos porcentuales hasta el 12,1%. En los años que precedieron a la crisis el crecimiento de la eurozona estaba en buena medida determinado por su periferia, en tanto que el crecimiento alemán se situaba por debajo de la media. El crecimiento alemán se beneficiaba de las exportaciones a los países periféricos. Ahora, el crecimiento económico de España, pero también el de Irlanda, depende mucho de las exportaciones. En España las exportaciones han sido los principales contribuyentes al crecimiento del PIB en los pasados años pero todavía no son lo suficientemente fuertes como para llevar al país al terreno del crecimiento positivo, dada la floja demanda doméstica. Se necesitarán más reformas estructurales en la periferia de la eurozona para conseguir el ajuste y aumentar las exportaciones. Eso incluye a los mercados de trabajo pero quizá de manera más importante a las numerosas regulaciones a nivel de empresa que frenan la competencia e incrementan las rentas mientras impiden el ajuste de precios. Pero también supondría una ayuda que el crecimiento alemán fuera más importante. Diría que hay tres factores primordiales que podrían ayudar a aumentar el crecimiento alemán y, por tanto, a acabar de manera más decisiva con la recesión en la eurozona: Primero, la inversión pública alemana es actualmente una de las más bajas de la Unión Europea y en muchas áreas se está convirtiendo en un cuello de botella para el crecimiento. Alemania se beneficiaría del reciclado de alguno de sus ahorros en inversión pública doméstica, especialmente en un tiempo en que los costes de financiación son tan bajos. El rendimiento de la inversión pública también debería ser más alto que el rendimiento que Alemania ha obtenido por sus inversiones en el

75 extranjero. De hecho, Alemania en conjunto tuvo pérdidas muy importantes en sus inversiones exteriores, incluido el mercado estadounidense de las subprimes. Segundo, podrían mejorarse aún más las condiciones para la inmigración. Mientras hace algunos años Alemania era todavía un país de emigración neta, en 2012 llegaron más personas a Alemania de las que dejaron el país. El floreciente mercado de trabajo significa que cada vez son más las empresas que tienen que buscar trabajadores especializados extranjeros para contribuir a la producción. Pero los inmigrantes no necesariamente tienen el nivel suficiente de habilidades requeridas. Una formación más especializada, la enseñanza del idioma e iniciativas por el estilo serían una provechosa inversión para Alemania y también facilitarían la migración de mano de obra desde países con alto índice de desempleo. Tercero, algunas parcelas del sector de servicios aún siguen estando fuertemente reguladas. Liberalizar ese sector ayudará a aumentar las actividades del mismo. Un sector de servicios liberalizado contribuirá de forma importante a la eficiencia del sector industrial alemán y una fuente de nuevos trabajos, incluidos los destinados a inmigrantes. Por supuesto, eso también desplazaría la estructura de la industria alemana hacia más servicios. Al mismo tiempo, el crecimiento alemán aumentaría. Tal desplazamiento también llevaría asociado un aumento de los salarios en Alemania, lo que estimularía una mayor demanda de productos extranjeros. Los recientes indicadores de confianza de la eurozona son alentadores, pero el regreso a una duradera salud de la economía del área todavía requerirá de importantes medidas adicionales. Estas incluyen reformas estructurales en la periferia de la eurozona, pero también en Alemania, así como pasos decisivos para sanear los balances bancarios y crear una unión bancaria. En su ausencia, el desempleo seguirá siendo alto por mucho tiempo. Guntram B. Wolff es director de Bruegel. Traducción del inglés de Juan Ramón Azaola. http://elpais.com/elpais/2013/08/08/opinion/1375965619_542224.html

ft.com Comment Opinion

August 12, 2013 5:41 pm Why the Fed needs Summers’ firefighting skills By Roger Altman It is only a matter of time before emergency tools are required again, says Roger Altman

©AFP The seal of the Federal Reserve Board of Governors It is strange to see the equivalent of a political campaign over succession at the US Federal Reserve. After all, the chair is a presidential appointment, subject to Senate confirmation. It is not an election and, in the past, deliberations over these appointments have always been private. However, leaks have fed a widespread perception that President Barack Obama will soon nominate either Lawrence Summers, his former chief economic adviser and former Treasury secretary, or Janet Yellen, the current vice- chair of the Fed board of governors, to the four-year term that begins in late January. Supporters of each, including some in the White House, are campaigning publicly, trying to sway the president. But this decision should not involve popularity or politics. Nor, like Supreme Court appointments, does it need to consider questions of balance. And it is not, like cabinet appointments, a matter of appointing an adviser to the president. Quite the contrary. The Fed is both independent of the executive branch and, more important, the most powerful group of financial firefighters on earth. So its chair is the world’s most important crisis manager. It was the Fed’s massive intervention that saved the world from a full-on global depression, following the collapse of credit markets in late 2008. Given recent history, it is just a matter of time before its emergency tools are required again. That is the right context for evaluating the forthcoming appointment. We are certainly lucky to have had Ben Bernanke, the departing Fed chair, in the job: he served heroically in this firefighter role and has established a model for the future. The implosion of Lehman Brothers in September 2008 triggered the worst financial crisis in the developed world since the 1930s. Indeed, there was a moment when lending to whole sectors of the economy ground to a halt. Mr Bernanke grasped the scale of the risk of an economic Armageddon and engineered a colossal monetary response. Ultimately, the Fed provided what Bloomberg has estimated to be a breathtaking $13tn of support for the US credit system. Further, it directly recapitalised and regulated the entire American banking system. That the US economy is recovering now, spurred by healthy bank lending, is a direct tribute to his leadership. More ON THIS STORY// Summers set to face uphill Fed battle/ Philip Stephens Summers or Yellen? Toss a coin/ Scott Sumner Summers is the wrong choice for

77 the Fed/ James Hamilton Why Yellen should lead the Fed/ Money Supply Parsing Obama for hints on next Fed chair ON THIS TOPIC// Markets Insight Big fall in US equities could mean Yellen is next Fed chairman/ Edwin Truman Fed chair should be outsider/ Central banking still a man’s world/ Global Insight Fed succession reopens Democrat wounds THE A-LIST// The A-List Sharif faces up to saving Pakistan from collapse/ History shows why we must take action in Syria/ Syria is following the same script as Afghanistan/ David Miliband Syrians need our help It may not be 2008 any more but serious financial crises are occurring with ever greater frequency. Since the mid-1970s, after a multi-decade period of global market calm, we have seen repeated currency, banking and debt crises, often bringing crippling economic effects to the regions that experienced them. The two most damaging of these have hit within the past five years. It is worth reviewing the record of these events and why they are repeating themselves. The decade beginning in 1979 saw a US dollar crisis, the Latin America debt crisis and the American savings and loan debacle. The first two required international rescues and the latter a giant bailout from Washington. Then, the pace of such disasters accelerated during the 1990s. Mexico’s finances collapsed, Russia defaulted, a large US hedge fund imploded and, scariest of all, much of southeast Asia fell into financial crisis in 1997 and 1998. Virtually all of these failures required emergency rescues, with the Fed, as the world’s most powerful central bank, in the lead. These events were, however, dwarfed by the epic credit collapse of 2008 and the eurozone sovereign debt and banking crisis that began in 2010. The former induced the worst US recession since the 1930s and years of stagnation. The latter has created depression-like conditions in southern Europe and halted growth across the entire continent. Without the Fed’s intervention, there would have been catastrophe. Why such repeated crises? The answer, in part, is globalised financial markets where a currency crisis in Thailand shakes New York. An additional factor is that the velocity of global money flows increases every year, driven by the pressure for investment returns. We have also seen weak financial policy and poor regulation in many of these instances. However, the message of history is the repetition of such crises and how the next one can occur at any time and from an unexpected source. Indeed, it is probably 50-50 as to whether Mr Obama himself will face one during the final three- and-a-half years of his presidential term – one that could even threaten his economic legacy. The next Fed chair, therefore, must be experienced in managing crises such as these. That brings us to the apparent choice between the two lead candidates. Full disclosure: I have worked with Prof Summers and know Ms Yellen slightly. Both are highly qualified in virtually every respect. But Prof Summers had the key role in the Clinton Treasury during both the Asian financial crisis and the Mexican default. And, later, in the Obama White House during the huge credit crisis in 2009. It would be hard to find an American who is more battle- hardened. That is why he should be the choice. The writer is executive chairman of Evercore and was deputy US Treasury secretary in 1993-94 http://www.ft.com/intl/cms/s/0/c4d41b2a-032f-11e3-9a46- 00144feab7de.html#axzz2e0Uvkkv9

ft.com comment Columnists August 11, 2013 3:16 pm Summers or Yellen? The best Obama can do is toss a coin

By Philip Stephens Barring a new emergency, the decisions taken by the Fed will be at the margin

The Bank of England Here is a small heresy. The brouhaha about Barack Obama’s choice for the next chair of the US Federal Reserve is in inverse proportion to the significance of the contest. It really does not matter whether it is Lawrence Summers or Janet Yellen. The world – and the American economy – will continue to spin. Now for a second piece of heterodoxy: Mark Carney’s headline-grabbing monetary policy changes at the Bank of England are much ado about, well, not very much. The new governor’s blueprint for forward guidance on interest rates raises as many questions as it answers. Its impact on the trajectory of the British economy will lie somewhere between negligible and nil. More ON THIS STORY// Roger Altman The Fed needs Summers/ Carney plays down rate policy scepticism/ Scott Sumner Summers is the wrong choice for the Fed/ James Hamilton Why Yellen should lead the Fed/ Editorial India needs more than a new broom ON THIS TOPIC// The Short View Bond yields defy forward rates guidance/ Bank of England holds rates and QE/ Aussie dollar rallies on growth boost/ Fed considers new repo tool to smooth exit PHILIP STEPHENS// No one left to enforce the global rules/ End of decades of delusion/ Afghanistan Out of sight, out of mind/ Philip Stephens Snowden least of US- Russia issues Central bankers are the new masters of the universe. The mood of the moment says politicians cannot be trusted and commercial bankers are crooks. That leaves central bankers as the repositories of public trust. I have nothing against them. They are too often beguiled by economic theory, but, all in all, they are an intelligent bunch. Many (not all) prize professionalism and public service above fame or fortune. The problem comes when they are invested with supernatural qualities. Much of the debate about Mr Summers versus Ms Yellen and the fanfare that has greeted Mr

Carney’s arrival in London are founded on the silly assumption, far too common in financial markets, that these folk are keepers of the philosopher’s stone. In truth, their role is to try to prevent harm by keeping an intelligent lid on the rate of inflation and by watching over the stability of the banks and financial system. As we now know too well, they failed dismally in this second task during the years before the crash. Their mistake was to worship at the altar of the new financial capitalism – all would be well if markets were allowed to operate freely. The rogues gallery of those responsible for bringing the world to its knees is a crowded space, but Alan Greenspan, the former Fed chairman, stands front and centre in any line-up. At moments of great emergency, central bankers can make a difference. The US Fed was fortunate in having Ben Bernanke to pick up the pieces. Few policy makers were as steeped in the lessons of the 1930s depression. Mr Bernanke had the cerebral confidence and the character to make the right calls. Elsewhere, some would credit Mario Draghi, the president of the European Central Bank, with saving the euro by rescuing policy from political paralysis among eurozone governments. I think that takes things too far – the big decision was the political one taken by Germany’s Angela Merkel to back the ECB over the Bundesbank. Mr Draghi certainty played his part, but the future of the euro remains in the hands of politicians. Likewise, the principal levers of national policy making. The appointment of Raghuram Rajan as head of India’s central bank is not going to rescue that country’s economy. Likewise, barring a new emergency, the decisions taken by the Fed will be at the margin. Mr Summers’ qualities are well known, not least to Mr Summers. Ms Yellen looks the quieter choice, but she too is said to be unafflicted by a lack of self-esteem. For all the forests that have been felled and bytes consumed in the debate about the succession, I have not seen any evidence that one or other would strike out in a radically different direction. As for Mr Carney, he wants to become prime minister of Canada. He may have a politician’s luck. He has tipped up in London just as the economy seems to be reviving. He is fortunate in his predecessor: Sir Mervyn King never shook off the charge of being asleep at the wheel during the credit boom and too slow to react when it turned to bust. Mr Carney is right to signal to markets that British borrowing costs are unlikely to rise for some time. But his formulaic linking of interest rates to a precise level of unemployment necessarily includes so many forecasting uncertainties and caveats as to more closely resemble forward guessing than guidance. A general statement of intent would have been better. In any event, the formidable structural challenges facing the British economy are not going to be met through the odd tweak in interest rates. Back in Washington, Mr Obama has admitted that “you would have to slice the salami very thin” to find policy differences between Mr Summers and Ms Yellen. So who should he choose? Easy. Toss a coin. http://www.ft.com/intl/cms/s/0/b37e77b4-00e4-11e3-a90a- 00144feab7de.html#axzz2e0Uvkkv9

Daily Morning Newsbriefing August 09, 2013 Last issue before the holidays: Can Brazil please make up its mind! This is the last briefing before our holidays. We will be back, Monday, 26 August. Brazil is clearly not happy with the way the IMF handles its engagement in the eurozone. The FT reports that finance minister Guido Mantega has called on the IMF to review its programmes for the eurozone periphery, in particular Greece. Mr Mantega made the statement to explain the reported difference with his IMF representative, Paulo Nogueira Batista. Mantega said in a statement that they both agree that the programmes need to be revised to make them more sustainable. The article goes into some detail of the domestic politics in Brazil that may behind Mantega’s U-turn after he appeared to have denounced his ambassador for not consulting with him before he abstained on an important IMF vote on Greece. In Greece, meanwhile, unemployment rate rose further in May despite the start of the tourist season, to 27.6% in up from 27% in April, according to ELSTAT. Labour ministry data also showed an increase in layoffs in some tourist areas. Kathimerini explains these developments with a rise in uninsured work in the tourism sector, the widespread use of apprenticeships and mutually agreed termination of work contracts for employees. Saccomanni ready to pick a fight with Berlusconi over IMU This was superficially the most important political issue for Italy’s governing coalition – the housing tax IMU, which Silvio Berlusconi’s PdL wants abolished, while the PD wants to keep it. Yesterday, finance minister Fabrizzio Saccomanni came out with a surprising discussion paper, in which he clearly supported the PD position, causing a furious reaction by PdL politicians, who had previously threatened to quit the coalition unless their key demand of an abolition is met. Corriere della Sera is quoting from the paper, which says that the cancellation of IMU, which would costs €4bn, and would have to be counter-financed by other taxes, would have be regressive. The paper discusses alternative options, such as a one-time abolition of the first tranche only, and various other ways of reducing the overall tax burden, but it rejects the outright abolition of the tax. Spain's political holiday be dominated by Bárcenas and Gibraltar Next week, the three latest Secretary Generals of the PP will appear as witnesses before the judge investigating alleged illegal financing of the party, the so-called Gürtel and Bárcenas cases. Current PP Secretary General and Castilla-La Mancha regional premier Dolores the cospedal will be at the court on Wednesday, while her predecessors Javier Arenas and Francisco Álvarez Cascos will do so on Tuesday. Javier Arenas was the leader of the Andalusian PP for many years until the regional elections in March last 81 year, while Álvarez Cascos was deputy PM under José María Aznar but fell out with the PP in 2010 and successfully contested the 2011 regional elections in Asturias leading his own regional party, Foro. Earlier this week, the PSOE demanded that the judge order face-offs between former PP treasurer Luis Bárcenas on the one hand and Cospedal, Arenas and Cascos on the other, as the latter are expected to contradict Bárcenas' earlier court statements on the PP's alleged shadow accounting. Europa Press writes that the PSOE also demands that PM and PP President Mariano Rajoy also be called as a witness. The Spanish opposition can take little comfort in the continuing Bárcenas case, however, as the regional government of Andalusia, led by a coalition of PSOE and the united left IU, is embroiled in a corruption scandal involving alleged embezzlement of public money through a fund set up in 2001 to subsidize severance payments in mass layoffs, which El País (English edition) now calls the largest corruption case in Spain's democratic history. This would have been the biggest political controversy of the Summer recess, were it not for the sudden rekindling of diplomatic tensions between Spain and the UK over Gibraltar. As El País (English edition) explains, the escalating spat was triggered by Gibraltar's decision to build an artificial concrete reef to regenerate fish stocks, in what Spain claims are its territorial waters. Spain stepped up its enforcement of border controls, which led to long queues and complaints, after which ABC ran a fighting interview with Spain's foreign minister José García-Margallo last Sunday, in which he suggested Spain might impose a fee to cross the border. The crisis forced PMs Cameron and Rajoy to hold a telephone talks after which each government gave contradictory accounts as reported by El País (English edition). The latest escalation has been the announcement of a conveniently previously scheduled stop at Gibraltar by a British nine-vessel naval response group, described by the Telegraph. Opposition to IMF/Rehn advocacy of wage deflation mounts in Spain The other controversy of the month of August is likely to be over the suggestion by the IMF and Olli Rehn that Spain should consider a 10% wage reduction to improve employment and competitiveness. After the Spanish government expressed its opposition to the idea, the political opposition and the unions also reacted with outrage, writes El País (English edition). Critics of the IMF and European Commission have highlighted that Olli Rehn's monthly salary exceeds Spain's median annual wage, and that Christine Lagarde raised her own salary by 11% on joining the IMF. More substantially, the group Economistas Frente a la Crisis (Economists against the crisis) in a blog post, criticised Olli Rehn's position arguing that the suggested wage reduction would further depress Spain's internal demand, raise inequality and prolong the recession beyond 2017. Also, that the likely effect is a boost of business profits but that depressed demand would discourage any increase in much-needed investment. Finally, that the position of the IMF which Rehn supports is based on a wrong diagnosis that Spanish crisis is due to a loss of competitiveness though excessive labour costs, when it is actually due to a collapse of demand. Spanish employers ask for further relaxation of labour laws Spain's employer association CEOE is asking the government to reform labour laws to allow firms to unilaterally reduce hours on employment contracts, allowing full-time contracts to be turned into part-time ones, writes Cinco Días. The CEOE also advocates a further relaxation of overtime rules, and the extension of trainee contracts to employees older than 30.

Portugal considered swaps to conceal deficit back in 2005 There was a new turn in Portugal’s ongoing controversy over ‘toxic swaps’ on Wednesday the treasury secretary Joaquim Pais Jorge resigned following media reports that he helped try to sell derivative contracts to a previous government that would help to hide the scale of the public debt and budget deficit. Pais Jorge denied any responsibility but confirmed in a written note to the SIC to have taken part in at least one of the meetings with the former prime minister Jose Socrates. Socrates government is said to have considered the use of financial instruments to affect the public deficit if problems occur towards the end of 2005, according to the Jornal de Negocios. Former staff members said it was considered as a scenario not a recommendation, and it never reached the prime minister. The government now admits that there are ‘problematic inconsistencies’ between the different statements of Pais Jorge, who just had started on the job as treasury secretary this month. The opposition Socialist Party called on the prime minister to clarify whether he still has confidence in the team at the Ministry of Finance, saying its credibility was “at zero”, according to Portugal’s NewsOnline portal. Brittan on the euro From the man who single-handedly invented the whole concept of economic commentary in newspapers comes a very clear-sighted column on why he thinks the eurozone will ultimately collapse, though with no timeframe attached. Samuel Brittan writes in the FT that the economic theory behind the euro – if you want to call it that – was that it would act as a harmonising force. Instead it has produced unsustainable relationships. He says there are four ways the situation could develop in theory:

1. Austerity succeeds, and growth resumes, but process could take years or decades; 2. peripherals stagnates for a long time; 3. Core to pursue aggressive fiscal expansion, or subsidise the periphery indefinitely; 4. Peripherals will ultimately leave the eurozone.There is no way of forecasting this, he sais but his instinct tells him that No 4 is most likely. O’Rourke and Taylor on the eurozone Kevin O’Rourke and Alan Taylor have an excellent analysis on the eurozone in the Journal of Economic Perspectives. Impossible to summarise, but they conclude that the minimum set for a survive would a genuine banking union, a eurozone-wide safe bond supported by the ECB, and a fiscal union to make of all that happen. The trouble is that the short-term problems are so massive that one will never get there. The solution of this crisis would include elements of looser monetary policy, high inflation, a weaker euro, debt restructuring, and fiscal stimulus in the core. We totally agree with the conclusions of this article, but would like to add that the minimum set of solutions set out in this article are the exact opposite not just of current policy, but also of pledges of future policy. Our own conclusion is thus that the eurozone’s survival is ultimately dependent on whether current policy pronouncements are lies.

Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.562 0.560 0.563 Italy 2.572 2.593 2.568 Spain 2.890 2.844 3.010 Portugal 4.914 4.921 5.175 Greece 8.288 8.222 8.05 Ireland 2.188 2.199 2.173 Belgium 0.880 0.865 0.874 Bund Yield 1.689 1.683 1.708

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.334 1.338

Yen 128.440 129.07

Pound 0.860 0.8612

Swiss Franc 1.228 1.2307

ZC Inflation Swaps

previous last close

1 yr 1.2 1.18

2 yr 1.41 1.38

5 yr 1.62 1.61

10 yr 1.96 1.95

Euribor-OIS Spread

previous last close

1 Week -5.414 0

1 Month -2.900 -2.7

3 Months 3.714 3.914

1 Year 28.914 30.814

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-08- 09.html?cHash=b50dc137d56b163ac20a4f79e6659d7c

Daily Morning Newsbriefing August 08, 2013 Spain tries to cheat itself out of a banking crisis El Confidencial provides additional details on the €51bn in deferred tax assets (DTA) of Spanish banks which, according to Basel III, will cease computing as core capital in 2014. This is on average 30% of bank core capital, but in the case of Bankia it is close to 70%. According to the paper, this and other capital accounting rules coming into force next year would bring Bankia's core capital ratio below 2%, likely precipitating a new state rescue. In principle the EU is allowing banks 10 years to offload DTA, but Bankia does not have the luxury of waiting because the market is demanding that banks already meet the Basel III requirements. Thus Luis de Guindos is negotiating with the European Union on a conversion of DTA into tax credits. Spain would likely argue that Italy carried out a similar tax asset conversion in 2011, and that countries such as Germany, France, the UK or the Netherlands even allow tax credits to be carried back to previous tax years. El Confidencial writes, however, that budget minister Cristóbal Montoro is not keen on the DTA conversion into tax credits as this would cost Spain an additional 5% in the debt- to-GDP ratio and hinder efforts to reduce the deficit. The reason DTA don't compute as core capital is that their value is contingent on uncertain future profits, whereas tax credits would immediately be redeemable in payment of any taxes due, and would thus compute as core capital. The whole point of Basel III was to exclude these dodgy tranches of funds as counting as core capital, such as DTA and silent capital in the case of German banks. The agreed ratios were already not very ambitious – and hardly sufficient to protect the taxpayer in another financial crisis. But the DTA into tax credits to bolster Bankia’s capital ratio just tells us that the Spanish banking system is bankrupt. They need to restore to accounting tricks. Furthermore, this is yet another situation in which Mariano Rajoy's decision to separate Economy and Finance into two ministries is causing political difficulties. It also appears that the Spanish government's insistence on not tapping 60% of the offered EU rescue funds as a matter of pride may prove costly. PdL threatens to break up coalition The markets have taken the immediate aftermath of the Berlusconi verdict in their stride, but it is far from clear whether it will have as little impact on the Letta government as people outside Italy have come to believe in the last week. The PD general secretary Guglielmo Epifani gave an interview to Corriere della Sera in which he said that there is no way the PD would agree to help Berlusconi avoid his sentence. Moreover, he added the PD can always form a loose alliance with the Beppo Grillo’ s Movimento 5 Stelle to write a new electoral law, for which it does not need the PdL.

The reaction by the PdL to these comments were ones of unbridled fury. Corriere covers this story on pages 2-9 of its paper today. We think this government crisis is murkier than usual. The grand coalition is clearly not working, and it seems unlikely that they will agreeing anything of substance, except a minor reshuffle of taxes, which has some minor distributional consequences, but is completely irrelevant for the Italian economy. The future of the Letta government will also depend on whether the Italian Senate will release Berlusconi from immunity, or whether some other trick might be found to keep him inside the game. The PD, meanwhile, is in a state of civil war, with Epifani trying to protect the interests of the party establishment, and Renzi trying to bring about change of unprecedented radicalism. Giavazzi and Alesina are getting pessimistic on Italy, and so is Johnson In their front-page column in Corriere della Sera, Francesco Giavazzi and Alberto Alesina write that one statistic expresses the true drama of the Italian situation. Average incomes have fallen in Italy by 14% over the last 20 years, while they stagnated in the eurozone, and rose in the US by 12%. In reference to a 2012 paper by the IMF, which scores the efforts by various countries on economic reforms, they noted that Italy was the worst in the eurozone, except for Greece. The only area in which Italy scored well was pension reform. The economic benefits of reforms for Italy would be immense, they write. Instead of raising taxes, Mario Monti should have cut spending. And the Letta government has also wasted its first 100 days, during which they did nothing other than agreeing to pay bills and a decision to abolish the provinces. Writing in Bloomberg, Simon Johnson has a broadly similar analysis. He says the real problem in Italy is not investments, which are higher than Germany’s in relative terms, but the role played by the state itself. The country needs reforms of a scale that is much larger than anything considered by the government now. With 130% debt-to-GDP Italy needs series spending constraints simply to maintain that ratio, even under assumption of low interest rates. And the government has no contingent funds to recapitalise a large bank, should that become necessary. He concludes by saying that there is much that could go wrong in Italy, and by extension in the eurozone as well. Strikes announced over mobility scheme in Greece Some 1300 out of 2000 state school teachers who are due to join the mobility scheme will assume jobs in the health service, Deputy Education Minister Simeon Kedikoglou told Mega TV on Wednesday, adding that he could not rule out “further horizontal cuts” due to delays in administrative reforms. Kedikoglou did not specify what kind of posts teachers would be assigned to the health service. He blamed reform delays on ex- Administrative Reform Minister Antonis Manitakis, from former junior coalition partner Democratic Left, saying the latter had “not believed in this reform” during his ministerial stint and had therefore dragged his feet. The head of the union of secondary school teachers (OLME), Themis Kotsifakis, reacted to Kedikoglou’s comments by declaring that his union would hold industrial action in September to protest the changes. Antonis Samaras, meanwhile, is in the United States to drum up interest for investments and to meet with President Barack Obama on Thursday at 10am, Kathimerini reports.

Finnish 2014 budget published today The Finnish 2014 budget is about to be published today. According to the draft the state budget for 2014 will be €53.9bn, slightly less than that of 2013; while the deficit will be €6.6bn, down by €4oo,ooo compared with 2013. The new budget raises the state debt to €98bn, pushing the debt ratio up to 59.2% of GNP next year and to 59.9% in 2015, national broadcaster YLE reports. According to finance minister Jutta Urpilainen, key features are measures aimed at improvements in productivity and employment. It also includes cuts in corporate taxation and capital gains tax that the cabinet approved in the spring. Opposition leaders did not reject the budget proposal outright, but insisted that more concrete measures should have been taken to stimulate the economy to get out of the recession. The proposal will be formally published today, discussed by the cabinet end of August and submitted to the parliament in mid-September. French trade deficit falls in June The French trade deficit shrank in June to €4.4bn from €5.71bn in May. Much of the improvement was due to a fall in imports to €40.1bn from €41.7bn. But exports also increased slightly to €36.2bn from €36bn. “Foreign trade will be a key engine of growth in 2014,” says trade minister Nicole Bricq. This might be over-optimistic, writes the FT, but there are other positive indicators. A survey for Les Echos of 31 of the top 40 companies in the CAC 40 stock market index to have reported first-half results so far, showed that although profits were down overall by 1.4% on the same period last year, almost 70% exceeded analysts’ expectations and many had seen improved performance in the second quarter. The CAC 40 itself has surged recently above 4,000 from a low of 3,341 last November. The government is convinced that a €20bn tax break it is phasing in for companies to help reduce high labour costs will help boost a turnaround. Figures from Eurostat, the EU’s statistical body, show France’s labour costs fell 2% in the first quarter. Portuguese unemployment falls for first time in 2 years Portugal's unemployment rate fell for the first time in two years in the second quarter, Reuters reports. The rate fell to 16.4% from a record high 17.7% in the first quarter, Wednesday's data from National Statistics Institute (INE) showed, with seasonal and underlying factors both contributing. The drop in the unemployment rate, helped by retailers preparing for the summer tourist season, was steeper than expected. But unemployment remains higher than a year ago, when it was 15%, and the government has said it expects it to top out at 18.5% next year after hitting 18.2% in 2013. Irish good exports set to fall this year The value of Irish exports are set to fall by €2.8bn this year, or 1.6%, according to the latest estimates from the Irish Exporters’ Association, as earnings from pharmaceuticals sales slip - the result of patents on a number of drugs manufactured here expiring, the Irish Times reports. Exports in the first six months of this year was down 1.9% over the same period in 2012. For the whole year it is thus expected that merchandise exports are expected to fall by €5.5bn this year while the value of services sold abroad would increase by €2.7bn. Another report on Merkel standing down in 2016 This from Stern magazine, via Reuters. Hans Ulrich Jorges, a senior editor of the magazine, whom we know and who is usually well informed, writes that Angela Merkel

87 plans to step down as chancellor in 2016, exactly one year before the 2017 general elections, to make way for a successor in her own party. We note that this story has come up before, and was denied vigorously at the time. It was denied again yesterday. Bini-Smaghi says transparency not always good Lorenzo Bini-Smaghi has a good commentary in the FT in which he discusses in some detail why US or UK style minutes may not be appropriate for the ECB. For a start, he argues, there is no evidence that the communications and policy guidance of central banks with minutes is in any way superior to central banks without minutes. Furthermore, he notes that the external voting members in the Fed constitute a minority, while they constitute a large majority in the ECB. There is a real danger of a loss of independence if voting records are published, he says. But he supports the idea of minutes showing a detailed rendition of the arguments used in the discussions. On comparison between the eurozone and Latin America in the 1980s This is via Brad DeLong’s blog. Barry Eichengreen, Naeun Jung, Stephen Moch, and Ashoka Mody have a joint paper in which they draw comparisons between the crises in the eurozone and in Latin America. “The longer the crisis in the Eurozone drags on, the more it looks like the ‘Lost Decade’ in Latin America in the 1980s than the ‘Phoenix Miracle’ of the East Asian countries following their crisis in the 1990s. In Latin America it took nine years for growth to recover sustainably to the levels prevailing prior to the crisis in 1982.2 The meantime saw a grinding process of internal adjustment characterized by debt overhang rather than debt reduction. East Asia’s crisis, in contrast, took the form of a v-shaped recession and recovery, with growth falling sharply in 1998, the year following the onset of the crisis, but recovering equally sharply in 1999 to levels nearly as high as before the crisis. The growth of debts was more limited, and exports increased dramatically. Internal and external adjustment was faster.” Munchau’s analysis of electoral programmes In part of 2 of his series on the macroeconomic sections of the elections platform, Wolfgang Munchau takes a look at the CDU/CSU, and does not find any. He writes this is not surprising. The CDU is a top-down type of party, where the chancellor sets the policy. But he notes that the absence of policies or even aspiration is a bad sign for a party that will not forever be in government, and which will fall into a big void. Munchau is particularly scathing on the programme’s reiterated emphasis on competitiveness, and on rumblings of the “digital future”, which would have been an appropriate subject for 1994 election campaign when Helmut Kohl was still rambling on about the analogue high-definition television. Over the next two weeks, Munchau will take a look at the programmes of the FDP and the Greens, which we will not be able summarise at the time because of the holidays. Instead, we are presenting a short preview here: while the CDU programme was macroeconomically void, both the FDP and Greens have a strong macro focus. That of the FDP, however, is toxic and paranoid, as it talks almost exclusively about monetary policy – the only strand of macro outside the immediate reach of politics. It is clear that the FDP wants to constrain the ECB in its role in the eurozone crisis. While some of the concrete demands may be hard to fulfil –such as a price stability mandate in the German constitution – the FDP’s obsessive focus with the ECB will matter in case the present government gets re-elected.

On the Greens, Munchau writes that their analysis of the eurozone crisis broadly resembles his own, though their macroeconomic programme is overloaded with issues that are not logically related to the crisis, but which the Greens want for different reasons. While he takes issue with a number of concrete proposals, Munchau applauds the fact that at least one party understands the underlying issues. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.565 0.562 0.559 Italy 2.565 2.545 2.561 Spain 2.859 2.890 2.882 Portugal 4.921 4.914 4.959 Greece 8.263 8.288 8.30 Ireland 2.175 2.188 2.202 Belgium 0.878 0.880 0.873 Bund Yield 1.701 1.689 1.673

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.328 1.3365

Yen 128.850 128.56

Pound 0.868 0.8614

Swiss Franc 1.232 1.2289

ZC Inflation Swaps

previous last close

1 yr 1.21 1.2

2 yr 1.42 1.41

5 yr 1.62 1.62

10 yr 1.97 1.96

Euribor-OIS Spread

previous last close

1 Week -5.114 -5.414

1 Month -2.900 -2.9

3 Months 4.314 3.714

1 Year 30.271 30.871

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-08- 08.html?cHash=de6fd5406c0d94dcad228c0940fe2f88

08/08/2013 06:02 PM German Stasis In the Grips of Merkel's 'Lethargocracy' By Markus Feldenkirchen and Christiane Hoffmann The German economy may be doing well now, but significant challenges lurk in the near future. Chancellor Merkel, though, has succumbed to the torpor of her electorate and has shown no willingness to address badly needed reforms. Social Democrat eminence grise Franz Müntefering is typing at his typewriter, an old Erika model. There is no laptop and no desktop in his office. He has spent his entire political life writing on the Erika, and now, in the final stretch, he isn't about to change. He is serving out his last few days as a member of parliament; the moving boxes are stacked behind the door of his Berlin office. Müntefering is 73, and he has been a politician for almost as many years. He has countless stories to tell about parliament and party headquarters, the kinds of anecdotes that many others can relate as well. There is, however, one experience makes Müntefering unique; he did something that no other politician has accomplished or even wanted to accomplish. He reformed Germany in a time of contentment. Müntefering was instrumental in the imposition of two unpopular measures on the country. The first came in 2003. Together with Chancellor Gerhard Schröder, he was responsible for pushing through far-reaching belt tightening measures, including welfare reform, designed to improve Germany's competitiveness. The package was known as Agenda 2010 and is one of the reasons that Germany has managed to weather the numerous financial, currency and economic crises that have struck Europe since 2008. A few years later, Müntefering struck again, taking aim at the retirement age. Unlike in 2003, Germany was doing relatively well in the spring of 2006 and the economy was booming. Nevertheless, Müntefering was convinced that the retirement age needed to be raised from 65 to 67. It was a textbook anti-cyclical approach, one which is hardly ever used in practice. He saw reforms as a kind of insurance for the future, to be undertaken at a time when the country was in good shape. 'Isn't Courageous Enough' At the time, Müntefering was vice chancellor during Angela Merkel's first term in office. "We decided on the reform together," he says of raising the retirement age. But it was unpopular and ultimately, Merkel backed away. "She left me standing alone out in the rain with the reform," he says. "Because she isn't courageous enough." Müntefering ultimately got his way. The SPD man had the courage to do something Merkel would never venture -- not then and not today -- and what hardly any democratically elected politician has ever ventured. He had the courage to ask something of the country, even though the mood for change was limited and the need for change unapparent. Müntefering introduced the reform because he believed it was his duty, and because he thought it was a smart move that would serve the country well in the future. "Come on, let's sit down," says Müntefering. He gets up from his typewriter, walks across the room and takes a seat at a small conference table. He is wearing a gray suit

90 with a gray tie, the outfit of a man who was never interested in looking glamorous. Democracy is great, says Müntefering. "There is nothing better. But unfortunately it's also very much tied to legislative periods." As he speaks, the ceiling of his modest office begins to shake, and so do the lamps and the window shades. It feels like a mild earthquake. "The subway," Müntefering mumbles when he notices the looks of concern on his visitors' faces. He doesn't even notice the rumbling anymore, nor does he complain that his party has assigned him, a former party chairman and deputy chancellor, to this type of office. The SPD didn't thank him for his courage, but instead held the reform against him. "Merkel and Co. are refusing to do many of the things we need to do for the future," says Müntefering. Of course he makes such comments with a view toward the ongoing campaign, but that doesn't make him wrong. The only question is: Is there a way out of the dilemma Merkel and other politicians find themselves in -- a way out of the stagnation that stems from the fear of being punished by voters? Do politicians have only the choice between lack of courage and loss of power? No Need for Action? The period since 2009 has been a domestic policy black hole. No reforms were passed that looked beyond just the next few years. Yet decisive action is critical, especially now -- notwithstanding the country's low unemployment rate, record-high tax revenues and an export economy that continues to set new records. But the situation is only looks rosy. Germany is not prepared for the changes that lie ahead. Clear structural reforms are necessary, and yet lawmakers deny that there is any need for action. Germany's social welfare systems are designed for a society that constantly generates growth and never ages -- in other words, for fair-weather conditions. Not even now, in times of historically high contributions and revenues, have lawmakers been able to compel pension, health and long-term care insurance companies to build adequate reserves for the more difficult times that lie ahead -- times in which one in two Germans will be retired and the number of the chronically ill and people in need of care will be twice as high as it is today. Those who fail to act now are only creating the crises of the future. The same applies to education policy. In a rhetorical sense, it may be an important element of all political speeches. But in reality, the promise to enable every child in Germany to have the best education possible has turned into a farce and the consequences will only become apparent many years down the road. The problems with education are not just the result of a lack of funding, but are also caused by the jumble of jurisdictions among the federal, state and local governments in Germany, where individual levels of government are mutually obstructive. And yet, no one is willing to tackle the issue. The fact that Germany still has one of Europe's most complicated tax systems is relatively unimportant, compared to other issues. Still, it is symptomatic. The task force on reforming the value-added tax rate, which was stipulated in Merkel's coalition agreement between her conservatives and the pro-business Free Democratic Party (FDP) hasn't managed to meet even once in four years. In the same period, the government hasn't managed to refrain from taking on new debt, showing little interest in reducing its existing debt of €1.053 trillion ($1.4 trillion), despite a propitious economy and record-high tax revenues.

Dramatic Dislocation While the government shies away from making necessary demands on its citizens, the steps it expects its European neighbors to take are harsher than ever. In interviews, Merkel often mentions the need for "fundamental structural reforms," and says things like: "Everyone must know that things cannot go on this way." But she is talking about Europe, not the country she runs. "A few more things have to change in Europe," says CDU parliamentary floor leader Volker Kauder. "We must continue to expect the states to implement their adjustments," says Finance Minister Wolfgang Schäuble. "This is tough for the population, but there is no way around it." The consequence of such statements is dramatic social and political dislocation in Southern Europe. One government after the next has stumbled or even fallen over the demands it was forced to make on its voters: pension cuts of up to 30 percent, slashes to social benefits and healthcare, and mass layoffs of government employees. All of this may be necessary, but Germany's austerity demands on the Southern Europeans would be more credible if it were willing to implement at least a fraction of these measures at home. But top politicians in Berlin are only bold when it comes to the citizens of other countries. As a result, Germany is stuck in a holding pattern that extends across all parties. The SPD has long since turned its back on the Agenda 2010 reforms and Merkel has concluded that citizens are unwilling to put up with the pain of reform. When Merkel is asked about the need for reform in Germany, she mentions the increase of the retirement age to 67 -- in other words, something that was already done, by Müntefering. Germany, she says, is a country where "you can see that reforms work." She prefers not to mention that the reforms that are working are not hers. Instead, her party has made campaign promises this summer amounting to about €30 billion in additional spending. Should the opposition manage to beat Merkel, it will be even more expensive. Plato said that democracy tends to make you fat and that democratically elected politicians would rather promise their people good deeds than prescribe them a diet. The Absence of Long-Term Thinking The stagnation is reflected in the lethargy of this election campaign, in which everything seems to have been decided already and is stuck in the languor of summer. Lawmakers are governing a nation that doesn't want to be bothered with unreasonable demands. According to the latest polls, the Germans are more satisfied with their government than ever before. Why then is Germany so worn down, and why do complacency and anxiety about the future go hand-in-hand? Whose fault is it: citizens or lawmakers? Few people have addressed these issues as intensively as political scientist Herfried Münkler, sociologist Ulrich Beck and philosopher Peter Sloterdijk. At first glance Münkler, 61, comes across like one of his contented fellow Germans. He is sitting in his office at Berlin's Humboldt University with arms crossed over his chest, practically hugging himself. But his thoughts are anything but pleasant. There are "cycles of willingness to change," he says. When a society has put certain efforts behind it, he explains, as was the case in Germany with the Hartz welfare reforms and Agenda 2010, it almost always succumbs to a "we've-done-it or we're-just- fine-the-way-we-are mood." But that, he says, is extremely dangerous, "because it's a

92 distraction from the fact that it is, of course, only an intermediate stage, the effects of which last for a certain amount of time and require quick follow-up." According to Münkler, the general perception of a crisis is the prerequisite for reform. Only when there is substantial pressure to act and simultaneous momentum in the media, he says, do politicians feel sufficiently emboldened to put things in motion. Tolerance for Frustration Besides, in a representational party democracy, politicians who make it to the top are rarely those with the greatest amount of courage and creative drive, but rather those with the greatest capacity to adapt. "The people who prevail in modern politics are those with the greatest tolerance for frustration and who those whose expectations of concrete results are lowest. Someone like that is most likely to master the process," says philosopher Sloterdijk, 66. "There ought to be a group of leading politicians prepared to take risks today for the sake of the future," says Münkler. But as soon as a handful of lawmakers muster the necessary courage, they find themselves reined in by their party, he explains. That's because politicians who are willing to take risks don't just jeopardize their own re- election prospects, but also those of other lawmakers in their own party. As a result, hardly any politicians today are capable of thinking long-term anymore. In addition to lacking the courage to support unpopular measures, they are unwilling to seriously address issues that don't require immediate solutions. Münkler calls this a "deficit of strategic thinking," and notes that lawmakers are rewarded for moral and not strategic thinking. But, he adds, what may seem moral in the short term can inflict serious damage on society in the long term. While politicians seem to be getting increasingly spineless, society is underdoing rapid change. "We are currently in a phase of dramatic change," says sociologist Beck, 69. "We live in a reality that is becoming more and more incomprehensible when measured against our beliefs up to now." We meet with Beck in the imposing villa owned by the Center for Advanced Studies in Munich's upscale Schwabing neighborhood. He points across the street, where the famed sociologist Max Weber once lived. "Change," he says, "hasn't just struck the family, occupational patterns and class structure, but it also affects the standards with which we evaluate change." According to Beck, a vacuum has developed over the issue of what society will look like in the future. Reality Overtakes Politics The pace of change is especially dramatic in the family. Women's participation in the working world has revolutionized the distribution of labor in the family and society. At the same time, hierarchies of living models have been dissolved in the last two decades. Nowadays, all kinds of lifestyles are equally acceptable in large segments of society, from marriage to cohabitation, gay to straight, long-distance relationships to living in the same house, and mixed families that sometimes consist of children from the respective spouses' previous relationships. Something else has also changed: Today one in three children in Germany under the age of five comes from an immigrant background. Reality is overtaking politics. Legal equality for gays and lesbians is lagging behind social acceptance. And the government was behind the curve in introducing a policy to make childcare and the education system conform to the working life of parents. Hardly

93 any other country spends as much on family policy as Germany, and yet the results have been modest. The birthrate has not increased significantly in the last few years, nor is Germany a pioneer when it comes to the compatibility of family and career. Politicians avoid providing answers for fear of alienating voters. This has led to a confused family policy. "We demand freedom of choice" -- the credo of Family Minister Kristina Schröder is a euphemism for a policy that lacks orientation. Beyond family policy, sociologist Beck sees this as the administration's biggest weakness. Chancellor Merkel, he says, has the power to make policy, but seems unable to do so. In other words, she is incapable of leading the way. On the trip to our interview with Peter Sloterdijk, the air-conditioning system failed in ICE car 29, shortly after Frankfurt. It was one of those hot, muggy summer days when it's impossible not to perspire, even when you're sitting completely still. The men in First Class took off their jackets, and dark spots soon appeared on their white shirts. One after another, they closed their laptops and stared apathetically out of the window. 'Chronic Mood of Tolerance' This continued until Mannheim and then Karlsruhe. Almost no one stood up to find a cooler spot in another car. Apparently it's easier to tolerate the heat than to take a step down to Economy Class. Hardly anyone complained to the train personnel. A "chronic mood of tolerance" prevails in Germany, says Sloterdijk, as we arrive for the interview an hour late. Whether it's on the ICE or in politics, we settle for meaningless explanations, like "operational problem." No one is to blame, nothing needs to be changed and there is no alternative. "Our politicians are like employees of Deutsche Bahn," says Sloterdijk. "If you complain, the only response you get is that they don't know any more than you do." "Debacle" is the first word that Sloterdijk thinks of in connection with the election. "On what day is the election?" he asks with demonstrative indifference. Sloterdijk, Germany's most famous philosopher, isn't going to vote this year -- out of perplexity, as he says. "In the past, being politically reasonable meant voting for the lesser evil. But what do I do if I no longer know where the lesser evil lies?" For some time, Sloterdijk has been saying that Merkel inherited a "lethargocracy" in Germany from former Chancellor Helmut Kohl. But politicians aren't to blame, he says. "The lethargy is coming from society," says the philosopher. "On this issue, lawmakers, for once, pay attention to the voice of the electorate." It isn't the chancellor or the government that are putting Germans to sleep. In fact, it is the Germans who are averse to change, and who want a sleepy government. To quote French philosopher Joseph de Maistre: "Every country has the government it deserves." Sloterdijk characterizes his fellow Germans as having "more separation anxiety than love of the future." Even though they are doing better than ever economically, Germans are anxious. They -- and particularly those who travel in First Class -- have the feeling that things can only go downhill from here. Lean Years? Even though the euro crisis has hardly harmed the German economy so far, it has introduced a sense of danger. Everything is fragile. The fate of the Southern Europeans fuels diffuse fears of decline. People know that there is nothing to guarantee that their current affluence will last. If the country can't even manage to reduce its debt in the current prosperous years, what will happen in lean years?

Such fears are justified. Given the slew of problems ranging from the debt crisis to overburdened social welfare systems, unfavorable demographic developments and economic growth that is moderate at best, everyone knows that the current situation is unsustainable. Government debt can only be kept under control with low interest rates, which undermine retirement planning. The stock market is booming, but only because of low interest rates, not because the economy is doing so well. According to Sloterdijk, an "anxious conservatism" is the result of a perception that reality is nothing but a house of cards. We are deceiving ourselves, so we don't mind being deceived by politicians. In the future, one of society's goals will likely be that of organizing scarcity as reasonably and equitably as possible. This is precisely what responsible politicians should be telling the Germans, namely that they should prepare for cuts in their pensions and the healthcare system, tax increases and more immigration. If democracy, with its fixation on legislative periods, can't muster the necessary courage, it will become its own worst enemy. The last metro train of the day rattles by beneath the office of Franz Müntefering. "We politicians should be less afraid of citizens," he says. If a politician can cite good reasons for a reform, people will understand it. "I think we underestimate people and their ability to understand relationships." 'History Will Prove Us Right' The next administration can look forward to four fresh, new years. In four years, it's possible to modernize a country and condition it for the future -- as long as the will exists to do these things. But it's also possible to hope for another four years of treading water while in office. Müntefering says that it would help if the political world, aware of its own weakness and corruptibility, made a commitment to change -- as it did with the debt limit. It could impose a condition on each new law, namely that it must be tested for its staying power. Perhaps it would also be sufficient for politicians to demonstrate foresight on at least one issue, and if they would ask themselves more frequently what future generations will think -- and whether anyone will remember them. Instead, most politicians focus on their re-election and not the day, 10 or 20 years down the road, when they are praised for taking a stand that, while unpopular at the time, is meritorious in the long term. Müntefering gets up with a smile. It's time to go. He seems completely at peace with himself. He pauses in the doorway for a moment to make sure he hasn't forgotten anything important. Then something occurs to him: "The nice thing about Agenda 2010 and retirement at 67 is that history will prove us right." That's worth more than another term in office. Translated from the German by Christopher Sultan URL: • http://www.spiegel.de/international/germany/germany-shuns-reform-and-change-ahead- of-election-a-915131.html Related SPIEGEL ONLINE links: • Photo Gallery A Country in Stasis http://www.spiegel.de/fotostrecke/fotostrecke-99979.html

• Chancellor Challenger Is Merkel Too Eastern for Europe? (08/07/2013) http://www.spiegel.de/international/germany/0,1518,915405,00.html • Single Issue Campaign: NSA Mudslinging Takes Center Stage http://www.spiegel.de/international/topic/german_election_blog/ • Halcyon Days Merkel's Party Unveils Cheerful Campaign Posters (08/06/2013) http://www.spiegel.de/international/germany/0,1518,915155,00.html • 'Hands Off My Sausage' (08/06/2013) http://www.spiegel.de/international/germany/0,1518,915064,00.html • Invisible Steinbrück Is the SPD Hiding Its Chancellor Candidate? (07/30/2013) http://www.spiegel.de/international/germany/0,1518,913982,00.html • 'Broken Oath' NSA Mudslinging Has Merkel on Defensive (07/15/2013) http://www.spiegel.de/international/germany/0,1518,911190,00.html • Lonely Struggle Wolfgang Schäuble's Fight to Save Europe (07/17/2013) http://www.spiegel.de/international/germany/0,1518,911076,00.html

Daily Morning Newsbriefing August 07, 2013 Steinbruck says ECB is expropriating German savings Oh dear. This is a campaign that is not going well. An increasingly desperate Peer Steinbruck is now criticising the low-interest rates of the ECB on the grounds that it disadvantaged German savers, who were now in an “unspeakable situation”. In an interview with Reuters, Steinbruck accuses Mario Draghi of expropriating the money of German savers through inflation that is running higher than interest rates. "That is an unspeakable situation so I am very sceptical about Mario Draghi's move to announce such a low interest rate policy - almost a policy of zero interest rates - for the ECB for the coming years". His “unspeakable situation” reminds us of Wittgenstein: of which you cannot speak, you should shut up. The interview is a clear demonstration of why Steinbruck is politically not in the same league as Angela Merkel, who by contrast is running a highly focused campaign. Instead of attacking the government, Steinbruck is chronically incapable of sticking to his message by lashing out at anything that crosses his way. And the comment that Merkel is a more distant supporter of European integration because of her east German heritage, his latest gaffe before this one, is politically illiterate because it unifies the left and the right in the east against him. The outcome of the election is still open in the sense that CDU/FDP may not necessarily maintain their current majority, but it is not very likely that Steinbruck is going to be the next chancellor. The comment also tells us that Steinbruck is not as economically literate as he makes it out to be. There is a reason interest rates are negative, because inflation, money supply and economic output have all well below their targets and reference rates for quite some time now. Jens Bisky on why east Germans are also Europeans Jens Bisky, journalist and the son of a former leader of the Left party, has a powerful comment in Suddeutsche, in which he writes that it happens all too often that criticism of famous east Germans, such as Angela or the footballer Michael Ballack, tend to be linked to their east German upbringing. Steinbruck said Merkel did not have the same passion for Europe because she has only become a citizen of the EU upon unification. For added insult, Steinbruck said this was not meant as a criticism, merely as statement of fact. Bisky makes the point that becoming part of a European Union was what drove east Germans ahead of unification. This was not purely a national event. He also argued that the east European freedom movements are historically just as relevant for today’s EU as the Franco-German reconciliation of earlier decades. Steinbruck has disqualified himself as chancellor precisely because he only thinks in terms of a narrow western European tradition.

Rehn’s supports 10% pay cut for Spain El Pais leads this morning with the story that Olli Rehn supported the IMF’s call for a pay cut of 10% for Spanish workers, to be stretched over two years, a proposal that was universally condemned in Spain. Rehn is quoted as saying that he understood the political challenge, but that this would be worth a try as a way to reduce unemployment, quoting from his blog. Such an agreement could cut the rate of unemployment from over 25% by 6 or 7 percentage points. Rehn uses the cases of Latvia and Ireland as examples. Rehn expressed hope that the recent labour market data signalled a turning point, but the recovery would in itself lead to full employment without further falls in wages. We find it hard to see how economy-wide wage agreements of such radicalism can be implemented in a large European economy. Spain is not Latvia. We also wonder whether the IMF and Rehn have actually looked at the entire dynamics of such extreme adjustment. The immediate effect of a 10% cut in wages and prices would be a large contraction of GDP, increases in reported debt-to-GDP ratios, and deficit-to-GDP ratios, which may have to be corrected by additional austerity, which in turn may lead to another vicious cycle of austerity and recession. This is not an experiment we would want to witness at close range. IMF wants Spain to clamp down on regional funding El País writes that, among the recommendations in the latest IMF report on Spain was a strengthening of enforcement of the existing Budget Stability Law. The law already allows the central government to intervene in the fiscal policies of regional governments if they miss their budget targets after just 3 months. The IMF suggests that the availability of monthly budget execution data would allow written warnings to be issued after just one month of a budget overshoot. The IMF report comes at a time when regional budgets are becoming increasingly contentious. Expansión writes that the 5 of the 17 regions, including Madrid and Catalonia, voted against the Spanish government’s assignment of deficit targets to the regions at the recent Council on Fiscal and Financial Policy. The overall deficit target for regional governments has been set at 1.3% by the Ministry of Finance and Public Administration, but regional targets vary, for instance 1.07% for Madrid and 1.58% for Catalonia. The Spanish government intends to have “asymmetric” deficit targets only in 2013. In the case of Catalonia, the regional premier Artur Mas reacted to the ministry’s proposed target by announcing his intention to not pass a budget for 2013, automatically extending the 2012 budget and resulting in a likely breach of the deficit target for this year, writes El País. The inability or unwillingness of CiU and ERC to agree an austerity budget for 2013 as they push forward with plans for an independence referendum is one of the most controversial open political issues both in Catalonia and in Spain generally. The economically illiterate Simon Nixon We are carrying this “hooray crisis over” article from yesterday’s WSJ because it highlights the naïve supply side view that has unfortunately many adherent especially in conservative political parties in Europe (and the US of course as well). Simon Nixon calls Spain an unprecedented experiment in using austerity and reform to get out of a debt crisis, and argues economic data released over the past few weeks point to an imminent economic recovery. Because, Nixon says, the construction sector has hit

98 bottom and unit labour costs have dropped, the stage is set for a business-investment led recovery despite future fiscal consolidation by the public sector presumably remaining a drag on the economy in the near future. Furthermore, he argues that market sentiment the credibility of Spain's bank restructuring is improving and funding conditions for banks, government and firms could improve soon. Nixon seems to have no idea of the scales involved. The Spanish export sector has been recovering, albeit from a low base, but the sector is small relative to the rest of the economy. As the IMF pointed out, unemployment will remain at over 25% for the next five years –something hardly consistent with a broad-based economic recovery. The Nixons of this world will, however, try to beat the drum that austerity is working, and that the economy is recovering. Spain to facilitate layoffs Last Friday, as part of a decree introducing new rules for social security contributions and pensions for part-time workers, the Spanish government made several changes to the regulation of collective layoffs, generally making them easier, writes El País. Foreign parent companies to present consolidated accounts to justify layoffs from a Spanish subsidiary on the grounds that the firm is suffering economic losses. Also, in the name of reducing legal insecurity, the right of individual workers to challenge a collective layoff is limited. In an open letter to the media, Spanish employment minister Fátima Báñez boasts that, in the first year of a plan against irregular employment and social security fraud, over 130,000 informal jobs have been brought to light. In the first half of 2013, in addition, 60,000 people have had their unemployment subsidy withdrawn for not meeting eligibility conditions, up 14% from a year earlier, saving nearly €1bn in subsidies. In the same letter, after mentioning “education in citizenship values”, the minister announces a new system to gather anonymous information on employment law violations. Could Portugal could take Spain down with it? Readers may remember the classic infographics Europe's web of debt from the NY Times (2010) or Who owes what to whom from the BBC (2011). Now, the Geo- graphics blog of the Council on Foreign relation focuses on Spain’s exposure to Portuguese debt and wonders whether Spain’s banking sector can survive an increasingly likely Portuguese debt restructuring, without eurozone debt mutualisation through ECB sovereign bong purchases on a par with that undertaken for Greece in 2010 on concerns for the stability of the French banking system. We recall that Spain left untapped €60bn of last year's €100bn EU banking rescue, and has given no indication of wanting to use that money before the end of the year while it is still available, ahead of the ECB's first banking stress test as Euro-wide banking supervisor. Greece rejects new austerity round rumours There are no plans to lower the minimum wage again before 2016, nor plans to abolish the 13th and 14th salaries, Kathimerini quotes Labour Minister Yiannis Vroutsis saying in response to reports over the weekend that the troika would demand such measures when it returns. Vroutsis’s comments come at a time when the Greek government is trying to form a united line of defence before the troika’s return. Administrative reform minister Kyriakos Mitsotakis became the latest cabinet member to suggest that the New Democracy-PASOK coalition, as well as Greek society, would not be able to survive if

99 forced to adopt these measures. “Austerity has been pushed too far. When our prime minister meets with President Obama this month, one of his main messages will be this.” Mitsotakis’s comments came just a few days after Finance Minister Yannis Stournaras told Reuters that the biggest threat to Greece’s adjustment program was not economic failure but austerity fatigue among coalition MPs. Portugal presents its pension reform Portugal presented its reform bill for public sector pensions to trade unions yesterday, with controversial pension cuts of up to 10%, a rise in the retirement age from 65 to 66, and a change in the calculation formula for new pensions, Journal de Negocios reports. The cuts apply across the board and relate to final-salary pensions, which are higher for those having entered retirement before the 2005 reference year. Minimum pensions will be protected, with the protected pension rising with age, starting with €600 for pensioners below 75 years in four more progression steps up to €1200 for the above 90 years old. The government also intends to change the pension formula for future pensions, which could apply already in 2013. The draft says the government would return the pension cuts if the economic situation improved as defined by a GDP growth rate of 3% and the budget deficit of less than 0.5% of GDP for two consecutive years. According to IMF forecasts, the earliest possible paypack would thus be 2017. The payback clause together with a protection of pensions below €600 and a minimum protection rising with age are dubbed as “trust criteria” by the government to help convincing the Constitutional court that the measures are not undermining the constitutional principle of protection of legitimate expectations. The bill is to enter into force in January 2014. The flow of eurozone money to London Chris Johns in the Irish Times argues that London’s property market has become the new “save heaven” for crisis weary investors from the Eurozone, causing a mini-boom in the housing market there. The fear of redenomination of bank deposits or its seizure, as happened in Cyprus, drives wealthy people to seek security elsewhere, traditionally in Switzerland and more recently also in London. The UK is seen as a haven of political stability, the rule of law are strong and fair, as are property rights. Saccomanni hails end of recession It was always clear that the politicians would seize on the first mild improvement in the economic data. Fabrizio Saccomanni yesterday hailed the release of data for Q2 GDP (- 0.2 qoq, -2% yoy), and and industrial production in June (+0.3% mom, -2.1% yoy) as a sign that the Italian economy is coming out of recession, as La Repubblica reports (deep in the paper, which is otherwise preoccupied with Silvio Berlusconi and any potential presidential intervention). Car production also registered a 7.4% improvement in June. Saccomanni said it will take some time for those figures to filter through to the labour market. How one can speak of end of the recession in view of catastrophic collapse of the labour market is extraordinary. But, yes, Italian GDP is going to register a nominal increase either in Q3 or Q4, as the dynamic of this recession is improving a little. But it will take a long time for Italy to emerge from this Great Recession which started in late 2008. Mauro on why Italy should say No In a front page commentary in La Repubblica, Ezio Mauro writes that Italy should simply say No to Berlusconi – instead of discussing ways to find an amnesty. All this is

100 done in the name of Berlusconi’s eight million voters. He writes the argument in favour of an amnesty – especially the argument that he has such broad political support – do not hold up logically. Italy is a constitutional democracy, in which all citizens are equal in front of the law. Berlusconi, when he was sentenced, asked not to be considered a citizen but a political leader who enjoys special status. He writes if Italy accepts this, it is on the verge of accepting a political philosophy of absolutism, authoritarianism and Bonapartism he writes. El Erian says crisis suspended for the summer This reads like someone who is about to go on holidays, hoping not to be bothered by a return of the crisis – something we can sympathise with right now as well. Mohamed El-Erian writes in the Guardian that the euro crisis is on hold during the summer, as official Europe is going on holidays, but also because of the German elections. Furthermore, the relatively positive recent economic news seems to justify the delays. But then he goes on to explain that this calm gives a misleading impression of reality: unemployment is still rising, adjustment fatigue is setting in, as is bailout fatigue. And the private sector remains oxygen-deprived, he writes. “All of this adds up to a sad reality for Europe. Despite hopeful blips in an economic indicator here and there, too many countries lack both immediate growth and longer-term growth engines. As a result, debt overhangs will remain problematic. Owners of private capital that could be allocated to productive investment will remain hesitant. And societies will continue to lack the jobs and capital investment that are essential for durable prosperity and general wellbeing.” Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.571 0.565 0.564 Italy 2.595 2.569 2.582 Spain 2.881 2.859 2.902 Portugal 4.889 4.921 4.896 Greece 8.296 8.263 8.29 Ireland 2.191 2.175 2.189 Belgium 0.883 0.878 0.876 Bund Yield 1.69 1.701 1.688

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.327 1.33

Yen 130.510 129.14

Pound 0.863 0.867

Swiss Franc 1.231 1.2317

ZC Inflation Swaps

101

previous last close

1 yr 1.2 1.21

2 yr 1.41 1.42

5 yr 1.61 1.62

10 yr 1.96 1.97

Euribor-OIS Spread

previous last close

1 Week -4.929 -5.029

1 Month -4.300 -2.9

3 Months 2.214 3.214

1 Year 28.829 30.429

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-08- 07.html?cHash=31054bedb48eb31e997cc84df58b9580

Daily Morning Newsbriefing August 06, 2013 A deal to save Silvio Berlusconi La Repubblica leads with the story that two of Silvio Berlusconi’s two most trusted lieutenants, Renato Brunetta and Renato Schifani, held a one-hour conversation with President Giorgio Napolitano over a deal to save Berlusconi and allow him to retain his seat in the Italian senate. Napolitano did not give any indication of what he could do, but said that he would consider all aspects of the case, without giving any details. What he did say is that the government itself must not be compromised. Linkiesta notes that the real danger for Berlusconi now is the “Ruby scandal”, which is ultimately a more serious case, where he stands accused of a sexual relationship with a minor. In a mini-summit with Eniro Letta and Iganzio Visco, Fabrizio Saccomani presented his latest plans for the reshuffle in the tax system, in which he only partly accepts the demands by the PdL to abolish the housing tax IMU on the first property, Corriere della Sera writes in a separate story. That measure alone would cost €4bn if in implemented in full, and was one of Silvio Berlusconi’s key demands. Letta said the government stood by its commitment to make a formal proposal before the end of the month – which is clearly seen as an important for the government’s chances of survival. The trio was also beating the drums of the recovery, which it expects to happen between the third and the fourth quarter. The latest positive economic news is the 4% annual growth of fiscal revenues during the first six months of the year, especially the money

102 collected in the fight against tax evasion. The government also expressed optimism on the recovery of the banking system. We are seeing here the beginnings of a possible, albeit dirty deal that would prevent the immediate break-up of the government – Berlusconi allowed to stay in politics against a commitment to support the Grand Coalition. That could be a positive outcome as long as this government implements political and economic reforms, which we do not, as yet, see. Panebiano on what happens if a weak power imposes reforms on a strong power Angelo Panebianco has a thoughtful commentary in Corriere della Sera this morning about the rush for justice reforms – one of the key demands by Silvio Berlusconi and his PdL. Penebianco notes that the rise of Sivlio Berlusconi 20 years ago began Italy’s second republic, while his fall unfortunately does not set the beginning of a third. He writes that Berlusconi’s sentence has ultimately not changed the political agenda, and has accelerated calls for justice reform – which is even supported by President Napoliano, who cannot be accused of partisanship on this issue. The question is: can a weak force like the Italian state impose a reform on a much stronger force – the Italian justice system? He does not think this is possible. And in any case, it is the political system itself that is in need of reform. 50,000 Catalan children suffer food deprivation The Catalan region's Ombudsman, the Síndic de Greugues has released a special report on child malnourishment in Catalonia. The report claims nearly 50,000 children (under 16), or 4%, suffer food deprivation, while 28% are at risk of poverty according to the latest European statistics. Nearly 10% of households cannot afford meat of fish at least once every two days, which is 6 times the rate before the crisis. Compared to the previous figures, only 64,000 children are eligible for subsidised school meals which the Síndic considers insufficient. IMF says France should scrap tax hikes for next year The IMF recommended that France should slow its 2014 fiscal consolidation plans to avoid hurting the weak recovery In its Article IV country report on France. It should scrap the plans to increase taxes, €12bn or 0.3% of GDP in measures - €6bn to compensate for less tax revenues in other categories and another €6bn to reduce the deficit – but keep up expenditure cut measures – 0.8% of GDP according to the French government or 0.5% according to the IMF, and to accelerate its structural reforms, Les Echos reports. The IMF warned that "a growth failure in France would have significant outward spillovers to its neighbours, particularly small open economies in the euro area, and smaller but still measurable impacts on Italy and Spain," according to the WSJ. The IMF tables a deficit forecast of 3.9% this year, 3.5% next and 3% in 2015. The French economy is expected to shrink -0.2% this year and to grow by 0.8% next year with unemployment reaching its peak with 11.6% next year. How Hollande plans to win his bet on unemployment Defying all forecasts of rising unemployment rates, Francois Hollande insists with his pledge that he will turn around the unemployment trend by the end of this year. Reuters took a closer look of how he wants to do this, by stimulation the jobs market now before the economy kick-starts in 2014: • When French children return to school in September, they will be welcomed by an army of 30,000 new classroom minders and playground assistants in many cases

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taken straight from the dole queues. Such public sector posts are a category of jobs whose average duration will be doubled to 12 months. • Funding so-called "jobs of the future" to help unqualified youths aged between 16 and 25 take up jobs in the health, charitable and other non-commercial sectors. The government estimates 2,500 such contracts are now being signed a week and expects to get close to a year-end target of 100,000; • training schemes aimed at matching the unemployed with the several hundred thousand job vacancies currently unfilled in France because of a skills mismatch. Hollande expects to fill 30,000 such posts this year and 70,000 more in 2014. • Hollande wants to encourage the private sector to take on 70,000 young people by giving companies financial incentives to train a young worker to replace an employee heading into retirement. • He also hope that a recovery will, by the middle of 2014, kick in enough to create employment by itself; There is no official forecast for how many jobless claims will be wiped out by these measures. Nor has the government disclosed the overall cost of the scheme. But even if he succeeds, critics would say he only cooked the books. Portugal considers using deficit relaxation to lower spending cut targets Portugal’s public debt is reaching 140% of GDP, the economic growth may turn out worse than expected and facing rising financing costs as warned by the IMF are realistic risks for Portugal’s deficit targets. But on top of all this is the perspective that the government might delay spending cuts. Over the weekend the Portuguese newspaper Expresso had the story that the Executive considers to transform €3.6bn in spending cuts in 2014 to just €2bn. This is equivalent of the troika proposal to increase the deficit target of 4% of GDP to 5% of GDP. But in combination all these factors are considered as a dangerous cocktail for a country that wishes to return to the markets in 2014, writes Jornal de Negocios. Within the Executive there is no consensus over expenditure cuts. The negotiation group under Paolo Portas wants to reopen negotiations over spending cuts. Another faction would prefer to use the leeway to lower taxes instead. As for now, the finance ministry continues to work under the 4% target assumption, according to the article. Crisis begins to bite in the Netherlands Yesterday’s front page in NRC Handelsblad wrote “After five years, the crisis is beginning to bite in the Netherlands,” referring to on the latest statistical figures from CBS Ihat tip Presseurop). Unemployment has risen from a pre-downturn level of 4% to 8.5%, and economic growth -1.8% this year. The article writes that the country changed since 2007, more old cars, more for-sale signs outside houses, more discount supermarkets, fewer babies and more adults who live at home with their parents. The article notes that “more than twice as many people are using food banks, assistance to those in debt has increased by 80 per cent, and that the number of suicides has shot up.” Germany’s Left refuses to support an SPD/Green minority government The SPD is manoevering itself into a corner. The Left Party said yesterday that it will not tolerate an SPD/Green minority coalition – which means that Peer Steinbruck’s most realistic chance of becoming chancellor – an inclusive election result - is now very unlikekly to happen. Suddeutsche has the report that the leadership of the Left Party is

104 about to make a formal declaration that it will not support a Red-Green government – a scenario that has recently become subject of much speculation and discussion. All the top party leaders are against this option. One of the reasons why the Left Party is becoming more hostile to the SPD is what is perceived Peer Steinbruck’s anti-East German attitude. The SPD candidate told Tagesspiegel – hat tip Die Welt - that Angela Merkel became a politician only many decades after the EU founding treaties. The statement was immediately interpreted as a criticism that Merkel is un-European because she is east German – though Steinbruck denies have insinuated this. But his statement nevertheless produced a predictable shitstorm. Eurozone retail sales decline in June Reuters reports that eurozone retail sales fell 0.5% in June, after a revised increase of 1.1% in May, citing figures from Eurostat. The annual drop in June was 0.9%. In Germany, retail sales were down 1.5%, the biggest monthly drop since December last year. The consensus among analysts quoted in the article was that the data are consistent with a steady, but weak economic recovery. Hetzel’s critique of the ECB This via Mark Schieritz, who dug up the following comments by Robert Hetzel, economist at the Federal Reserve Bank of Richmond, who said the ECB should engage in large scale QE to stimulate nominal demand. He accuses the ECB of lacking a coherent strategy for creating the monetary base required to sustain the money creation in a growing economy. But he gets more specific. “The ECB should buy packages of government securities to whatever extent necessary to create strong growth in aggregate nominal demand. It can use nominal GDP growth as a target and M1 growth as an indicator.” There is much more than this in his comments, also about his disdain for what he considers to be an attempt by the ECB to use monetary policy for structural change. We are more sceptical about advice to encourage European to be more American, like Michael Burda’s recommendation to group national central banks into regional central banks, or Hetzel’s radical proposals for NGDP, which not even the Fed has implemented, or is likely to implement. And while we prefer a programme of straight QE over OMT, we are not sure whether QE can be highly effective in the eurozone as long as fiscal policy is as constrained.

Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.549 0.571 0.571 Italy 2.619 2.585 2.585 Spain 2.902 2.881 2.867 Portugal 4.927 4.889 4.882 Greece 8.350 8.296 8.28 Ireland 2.243 2.191 2.195 Belgium 0.853 0.883 0.881 Bund Yield 1.65 1.69 1.69

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Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.329 1.325

Yen 130.740 130.5

Pound 0.865 0.8636

Swiss Franc 1.233 1.2309

ZC Inflation Swaps

previous last close

1 yr 1.47 1.2

2 yr 1.41 1.41

5 yr 1.61 1.61

10 yr 1.97 1.96

Euribor-OIS Spread

previous last close

1 Week -4.329 -5.629

1 Month -2.500 -3.6

3 Months 4.286 3.886

1 Year 31.643 30.443

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-08- 06.html?cHash=b7438e1fe877874401a99d4a676fbc95

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ft.com Comment Editorial August 6, 2013 4:33 pm A strong commission is the key to a stable Europe By Mujtaba Rahman The fact that creditors ignore the body’s advice does not mean it is wrong, writes Mujtaba Rahman

©EPA Everyone loves to bash the European Commission. In normal times, it is portrayed as remote, inefficient and unaccountable. But since the eurozone debt crisis, more serious charges have been made about its understanding of finance and financial markets. The most recent is the International Monetary Fund’s internal review of its own involvement in the first Greek bailout. It blasts the commission’s lack of experience of overseeing countries’ structural adjustment, and of crisis management more generally. Criticism of the commission has, in fact, defined the commentary on the debt crisis. When there is scrutiny of the IMF, the European Central Bank and the commission – the troika that organised the Greek bailout – the commission is always portrayed in the least favourable light. Despite several policy blunders by the IMF, eurozone members continue to have confidence in its technical competence. Meanwhile, the ECB’s programme of outright monetary transactions, or bond-buying, is credited with reducing the risk of a eurozone break-up. More ON THIS STORY// Cyprus reforms on track but risks remain/ Asmussen calls for bank resolution fund/ In depth Greek debt crisis/ In depth Eurozone in crisis/ Brussels moves to curb card fees IN OPINION/ China has a choice – short-term growth or sustainability/ Australia, US and the ties that bind/ Graham Stuart School tables deserve a D/ Guillermo Ortiz EM crisis threatens global recovery The commission, for its part, has not done everything right but it has done a far better job than its critics claim. This is especially true given Europe’s complex political structure and the constraints that member states impose on the commission as a result. Most importantly, unlike its troika partners, the commission is not ideological but pragmatic. Given the interdependence of eurozone economies, it has emphasised the importance of mitigating contagion. This necessitates a more supportive stance towards bailouts, which has led Germany to perceive the commission’s leadership as spendthrift and Mediterranean. However, as guardian of the treaties, the commission has had to

107 place the broader European good above the narrow self-interest of a small number of powerful creditors. The commission also understands European politics, and their interaction with economics, in a way the IMF does not. The Cyprus debacle is a perfect example. Wary of contagion, the commission put forth proposals that would have avoided imposing losses on Cypriot bank depositors. The IMF, given its desire to reduce the final tab so that its “debt sustainability” criterion would be met, was less against imposing such losses. The IMF knew it could win: its involvement was needed to secure the agreement of both the German and Finnish parliaments. In the end, the Cyprus package did, as the IMF wished, hit depositors. There has been no direct economic contagion; but the intervention did necessitate the introduction of capital controls, which are clearly inconsistent with a monetary union. Most importantly, the intervention complicated political discussions on “bailing in” investors, undermining elements of the eurozone’s proposed banking union. Furthermore, given recent local financial sector developments, it is likely Cyprus will need more money before too long. As bailout politics quickly become linked in Europe, this could have a negative impact on discussions of Greece and Portugal as they seek to graduate from their first bailouts this year. This is the type of political spillover the commission factors into its crisis management policy advice. The fact that creditor countries choose to ignore it does not mean it is wrong. One can look more critically at the way the IMF and eurozone member states handled Greece, too. The IMF acknowledges it overestimated Athens’ long-term political commitment to the bailout programme; yet the commission receives no credit for correctly foreseeing the government’s inability to implement reforms. In fact, the structural problems in Greece were such that shock therapy was the only viable way forward. The longer the reform programme lasted, the more likely the commitment of the Greek political elite would have waned. Although the IMF now acknowledges there was little option but shock therapy, because eurozone states were unwilling to lend any more money, it still argues imposing haircuts on private investors in Greek sovereign debt early on would have been beneficial for the economy. However, the broader political, economic and financial implications at that time were – and remain – unknowable. Germany, France and other powerful states continue to advocate a eurozone built on country co-operation rather than strong institutions such as the commission. But his is self-serving. Such demands created flaws in the design of the eurozone, which led to the build-up of imbalances and the onset of the crisis. Even now, reforms at both country and European levels remain fragile as a result. Country-level decision-making has proved an unfit basis for broader European stability. Ultimately, a eurozone that is both durable and successful will require more powerful – and accountable – supranational institutions. Of all those that exist, a strong European Commission is the best placed to fulfil that role. The writer is a former commission official, director of Europe at the Eurasia Group and author of the forthcoming ‘Inside the Crisis’ http://www.ft.com/intl/cms/s/0/1120d376-f947-11e2-a6ef- 00144feabdc0.html?ftcamp=crm/email/201387/nbe/BrusselsBrief/product&siteedition=i ntl#axzz2djDkc1ks

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Daily Morning Newsbriefing August 05, 2013 Silvio Berlusconi defuses immediate threat of a government breakup Silvio Berlusconi is portraying himself as a victim, but he also made clear that he does not want the Italian government to collapse, as both Corriere della Sera and La Repubblica report this morning. Nothing dramatic is going to happen immediately. In its front-page report La Repubblica also writes that there is room for manoeuvre and for negotiation, after Berlusconi had spoken on the telephone with President Giorgio Napolitano. At a rally in Rome by his supporters, Berlusconi emphasised the need for justice reforms, as Il Corriere della Sera reports in another article. La Repubblica reports that all senior PdL ministers have offered to resign in a show of support with Berlusconi. Meanwhile, according to PdL sources, Berlusconi is now considering whether he wants his verdict transformed into community service or into house arrest –the two choices available for people over 70 in lieu of prison. Berlusconi will have until mid-October to notify Milan prosecutors of his choice. In a front page editorial in Corriere della Sera, Sergio Romano said the PdL tries to make people believe that the travails of Silvio Berlusconi were the most pressing problems the country was facing at the moment. Linkiesta’s Marco Alfieri writes that the system that separates Italians into pro- or anti-Berlusconi camps is destroying the country. As long as that bipolar system remains in place, Italy will be at risk, Alfieri writes. IMF forecasts lost decade for Spain, advises 10% wage reduction On Friday the IMF released its latest report, on the IMF Executive Board's consultation with Spain. The press release gives an optimistic assessment that "imbalances are correcting rapidly" as the current account balance turned into surplus and the public deficit was reduced from the previous year. The Fund, however, recognizes that the unemployment situation is dire. The report takes a positive view of the labour market reforms "in line with [IMF] recommendations" and of the bank restructuring and the creation of the SAREB 'bad bank'. The most controversial policy recommendation was that the government broker a bargain between employers and unions for a 10% reduction in wages to improve employment, as reported by El País, English edition. However, a spokesman for the Economy ministry rejected the advice. The IMF's forecasts that Spain's economy will grow below 1% until at least 2018 and unemployment will stay at the current levels at least until then have also been widely covered in the press. Foreign tourism into Spain at 5-year high as domestic tourism sags According to figures given by Spain's industry minister José Manuel Soria, the number of foreign tourists in Spain in the first half of 2013 was the highest since 2008, writes 109

Expansión. Domestic tourism is not doing so well, admitted the minister in a radio interview last week. Europa Press reported that domestic tourism had dropped by 6% from a year earlier, as people are travelling less and staying with relatives. The drop in domestic tourism which was more than compensated by the improvement in foreign tourism. Soria said he doesn't believe domestic tourism will recover until the economy picks up again. French employers to finance pension reform exemptions The French government is currently working on the exemptions to the French pension reform. Last week Social minister Marisol Touraine confirmed that a credit point system will be created for employees that accounts for special hardship criteria, such as night work, exposure to cancer-related products, heavy weights, long shifts etc. These points will allow to enter earlier into retirement. Every month, the employer would have to declare how many of those criteria his employee has faced. For each of those criteria the employee gets one point, for 10 or 15 points he gets 3 months earlier into retirement. Cost simulations are difficult but first estimates suggest that these exemptions could result in €2bn on top of the €6bn-€7bn that are needed to bring the pension fund into equilibrium by 2020. To finance these, there is an extra contribution from companies in discussion, much to the chagrin of the employers, Les Echos reports. This contribution would have to be paid by all employers even the ones that do not account for any of those “hardship” points. It would be an extra charge raised similar to the accident insurance. Among the open issues is whether the measures should be applied retroactively and whether to limit those criteria to those clear cases of hardship or include those grey zone areas. Portugal uses its pension fund to reduce public debt figures One of the last acts of Vitor Gaspar in office as Portugal’s finance minister was to sign off an order that allows the Financial Stability Fund of Social Security (FEFSS), which serves future pension payments, to sell assets held by the fund abroad and to increase investment in Portuguese public debt to 90% of the portfolio, Jornal de Negocios reports. The measure is to lower the burden of public debt in GDP, which according to the Bank of Portugal reached 127% in April, to more sustainable levels. As the Social Security is part of the state, buying this debt means that debtor and creditor become the same entity. This, according to the EU criteria, cancels this debt on the paper. Negocios reminds its readers that this was exactly what José Sócrates planned to do in 2011 and for which he was heavily criticised by the then opposition leader, Passos Coelho. Today, as prime minister, he plans to do exactly the same. Chris Johns wants to condition austerity on growth The online columnist Chris Johns of the Irish Times has an original proposal, as a way forward in the austerity-versus-growth confrontation, which is currently raging between the Irish coalition MPs. He suggests a new rule that conditions austerity to growth: countries would oblige themselves, perhaps via constitutional amendment, to tighten fiscal policy subject to economic growth. For every 3 percentage points of growth in GDP the government will implement budget cuts worth 1% of GDP. These cuts will continue, if growth permits, until the budget is balanced at full employment. Though it is most unlikely that we will ever see such a rule in place to benefit the current bailed out countries, the debate is still worth having. An anti-cyclical rule will be challenging to design, certainly 3% is not something many countries would be able

110 to muster. And a rigid rule is this one as well, even if it sounds better. There needs to be a clearer distinction between budget cuts and reforms. Reforms are there to increase growth potential. Painful cuts will have to happen not only when pressed against the wall and politicians will have to refrain from their instinct to claim the funds for their voters. Still, there is something promising about reserving consolidation for good times, especially from today’s perspective. SPD says grand coalition only without Angela Merkel We are not entirely sure what to make of this story – as reported in Frankfurter Allgemeine. Peer Steinbrück reiterated in a ZDF interview that he himself would not be available for a Grand Coalition, while aides to Steinbruck said later that an SPD precondition for any grand coalition would be a chancellor other than Angela Merkel. Steinbruck also said he would not seek an alliance with the Left, while the Left’s leader in the Bundestag, Gregor Gysi, said there is no way the SPD could ever govern without its support. Steinbruck has no chance against Merkel, he said. The CSU is concerned that it might lose voters to the FDP especially if the FDP fails to clear the 5% representation hurdle in the Bavarian state elections a week earlier. If that were to happen, the outcome of the election could become highly unpredictably, according to Horst Seehofer, CSU chief. The latest polls give the combined CDU/FDP a share of between 45 and 47%. ZDF Politbarometer has the CDU/CSU at 40%, FDP at 5%, SPD at 27%, Greens at 14%, and the Left at 7%. That result would not give the present government a majority. The alternatives would then be a Grand Coalition, or a coalition of SPD, Greens, and the Left. Bild has an overview of the polls, including commentary from pundits who say the outcome is much more open than people generally believe. Gregor Gysi is right. It is hard to see how the SPD could nominate a chancellor without the support of the Left party. The SPD has slumped dramatically since the days of Gerhard Schroder, who won over 40% in his first elections, and still managed to get a respectable 35% when he narrowly lost out to Merkel in 2005. There are many in the SPD who are violently opposed to another stint as a junior partner in a Merkel-led coalition. Since Steinbruck has ruled out every realistic option for himself – a Grand Coalition or a coalition with the Left - the one thing that is (almost) certain is his departure from front-line politics – unless the SPD manages an unlikely recovery in the last few weeks of the campaign. But even then, the strategic options are not likely to change. These German elections promise to be interesting after all – though we doubt they will have much of an impact on the eurozone crisis. John Dizard on aftermath of German elections In a commentary in the FT, John Dizard takes a look at what will happen after the German elections. Given the position expressed ahead of the election, this is the scenario Dizard envisages: “…the new German government will be obliged to make outraged noises and stubbornly continue to deny that any further debt relief is needed. If it is, some German politicians will insist that private sector bondholders must take even deeper losses than they did at the time of the March 2012 restructuring. You can expect an even more bitter counter-reaction in Athens. This will do some serious damage to the price of Greek government bonds and those GDP warrants. That’s when I think the speculators will, once again, hoover up some more Greek risk.”

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Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.559 0.549 0.554 Italy 2.700 2.686 2.692 Spain 2.922 2.902 2.980 Portugal 4.752 4.927 5.237 Greece 8.370 8.350 8.33 Ireland 2.217 2.243 2.662 Belgium 0.863 0.853 0.867 Bund Yield 1.67 1.65 1.644

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.321 1.3281

Yen 131.810 130.9

Pound 0.872 0.8689

Swiss Franc 1.238 1.2334

ZC Inflation Swaps

previous last close

1 yr 1.46 1.47

2 yr 1.41 1.41

5 yr 1.6 1.61

10 yr 1.95 1.97

Euribor-OIS Spread

previous last close

1 Week -5.629 -5.529

1 Month -4.500 -3.1

3 Months 2.557 3.757

1 Year 32.300 31

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-08- 05.html?cHash=7de0fc6309010209d8bf308b053243f6

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ft.com Comment Opinion

August 4, 2013 3:28 pm Why Obama should pick Yellen to lead the Fed By James Hamilton An analysis of the accuracy of predictions by 15 Fed officials put her on top, writes James Hamilton

©AFP The seal of the Federal Reserve Board of Governors President Barack Obama was recently asked what kind of person he is looking for to head the US Federal Reserve. His answer: someone who will help the economy grow while keeping inflation in check and making sure we do not create new instabilities in financial markets. I think that is an excellent assessment of what we need, and a good summary of why Janet Yellen, the Fed’s current vice-chair, would be the right choice. Ms Yellen was one of the first Fed officials to see the problems developing in the US housing market. In late 2005, for example, when she was president of the San Francisco Fed, she explained her concerns about the housing market. “If house prices fell,” she warned, “the negative impact on household wealth could lead to a pullback in consumer spending. Certainly, analyses do indicate that house prices are abnormally high – that there is a ‘bubble’ element.” More ON THIS STORY// Americans have it wrong Washington ain’t that bad/ Senator grapples with financial ‘octopus’/ Comment Hurdles next Fed chair must clear/ Mike Konczal Bernanke did well but Fed must do better/ Editorial What the Federal Reserve needs ON THIS TOPIC/ Markets Insight Big fall in US equities could mean Yellen is next Fed chairman/ Edwin Truman Fed chair should be outsider/ Roger Altman The Fed needs Summers/ Summers set to face uphill Fed battle IN OPINION/ John van Tiggelen Change at the top Down Under/ Bruce Schneier Spooks need new ways to keep secrets/ Nick Clegg London needs HS2 as much as the north/ John Armitt UK needs an infrastructure strategy Many respected analysts, within and outside the Fed, did not share her appreciation of what was going on. In August of that year, Professor Raghuram Rajan of the University of Chicago presented a paper at the Fed’s Jackson Hole conference that proved to be a prophetic analysis of the problems developing in financial markets. He warned that the combined effects of deregulation, complicated new financial products, and the 113 overreliance of the financial system on short-term borrowing had produced a fragile environment, suggesting that incentives for excessive risk-taking could lead financial managers to “follow the herd into disaster”. His ideas were rejected by most of the distinguished professors and central bank leaders who attended the conference. Harvard’s Lawrence Summers – who is now Ms Yellen’s main competitor for the Fed chair – said that he found “the basic, slightly Luddite premise of this paper to be largely misguided”. At the outset of the crisis, however, Ms Yellen was also one of the people who saw most clearly the magnitude of the problems facing the economy as Prof Rajan’s predicted financial disaster began to unfold. Her speech to the National Association for Business Economics in 2007, when reread today, strikes the reader as amazingly prescient. Many Fed officials at the time felt that, since the subprime mortgages represented only 10 to 15 per cent of all mortgages, problems with these loans would not be enough to cause major economic damage. But Ms Yellen noted that the complex system of derivative instruments linked to subprime mortgages, such as collateralised debt obligations and credit default swaps, could lead to great uncertainty among lenders about the vulnerability of particular borrowers and a devastating withdrawal of credit. Ms Yellen further emphasised that the mathematical models companies had used to evaluate the risks of those instruments took insufficient account of the consequences of a significant downturn in house prices. Again, her assessment proved to be right on the mark. Ms Yellen has also been a leader among Fed officials in recognising that the economic recovery that began in 2009 would be disappointingly slow and continue to need assistance from the Fed. Its programme of quantitative easing, of which Ms Yellen has been a key supporter, is not without some controversy. There were many analysts who predicted that these policies would produce runaway inflation. But the inflation rate in the past four years has been the lowest since 1966. So far, at least, the critics have been proved wrong – and Ms Yellen right. The Wall Street Journal recently performed an analysis of the publicly issued predictions by senior Fed officials in the past four years, comparing them with what actually happened. Ms Yellen came out top among the 15 people whose records were examined. As someone who has known Ms Yellen since her days as a professor at Berkeley, I have some thoughts about how she does it. She has a very impressive intellect but does not feel a need to show it off. Instead, she has an amazing knack for always asking the right questions. If someone disagrees with her, her first instinct is to try to understand why they have reached a conclusion different from her own. For this reason, Ms Yellen is one of the people I would most trust to find out what the key problems are and what needs to be done in any new situation. But her intellectual openness should not be construed as a lack of toughness. Precisely because she has a gift for analysing the situation very clearly, she is also very committed to following through on what she perceives to be the appropriate policy. Finally, I would like to call attention to Ms Yellen’s straightforward way of expressing herself. I expect her to be among the most effective leaders in the history of the Fed at communicating what it is trying to do and why. That is something that will surely be welcomed by both Wall Street and Main Street.

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The writer is a professor at the University of California, San Diego http://www.ft.com/intl/cms/s/0/39d11f28-fb50-11e2-8650- 00144feabdc0.html#axzz2e0Uvkkv9

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Daily Morning Newsbriefing August 02, 2013 What now after the Berlusconi verdict? The Italian Supreme’s Court upheld a tax-fraud conviction against Silvio Berlusconi making a four-year prison sentence definitive, as Il Corriere della Sera reports. Thanks to a 2006 judicial amnesty, three years of the sentence are not effective and Berlusconi likely won’t have to serve the remaining year in prison, but will be given social work or house arrest as punishment as he is over 70. The most important news is that the court suspended the five-year ban from public office, sending this part of the verdict back to the Milan Appeals Court for a review that should be completed by September 2014, according to Il Corriere sources. So what are the consequences for Enrico Letta’s fragile government? According to Il Corriere, the PdL could threaten to pull the plug to Letta, despite several party’s MPs saying they would keep backing the government after the ruling. As the ban from public office has been sent to review, Berlusconi won’t be forced to step down as Senator or quit from the PdL immediately, a situation that could prove destabilising if Berlusconi decides to resign as Senator, as Il Sole 24 Ore’s Barbara Fiammeri writes. In this case, Italy could be forced to return to a vote due a mass resignation of PdL MPs. There are some signs of it. Several PdL MPs, like the Cabinet Undersecretary Micaela Biancofiore, said Berlusconi was a victim of a politically biased judicial system that dates back a long time and is fed by foreign powers. There is the possibility that Berlusconi’s supporters could rally round and encourage Berlusconi not to give up, and ask for new elections. As La Repubblica reports, PD secretary Guglielmo Epifani asked to PdL to continue to back the government but it is unclear what Berlusconi’s party will do. Epifani also said the verdict should be respected, carried out and applied. If so, as Linkiesta’s Alessandro Da Rold writes, after 20 years of active politics, Berlusconi could start his exit strategy by accepting the verdict and going to house arrest. In this case, without a leader, the Italian centre-right cannot help the country to exit from the current stalemate, Da Rold writes. Cassa Depositi e Prestiti plans to invest €95bn Cassa Depositi e Prestiti, the Italy’s government’s savings and finance arm, will invest up to €95bn, nearly 6% of Italian GDP, into investment projects targeted at expanding the CDP’s range of activities over the three-year period 2013-1015, Il Sole 24 Ore reports. According to the CDP’s new industrial plan guidelines, it will support investment in public administrations, financing 'smart' infrastructure, innovative enterprises and exports. It also plans to focus on regional development in the south, in energy networks and other strategic assets, as well as the internationalisation of Italian SMEs. The funds will arrive from savings. In the period between 2011 and 2013, the

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CDP expects to have mobilized resources worth €57bn, or €14bn more than originally planned, the institution said. Rajoy admits mistake of trust but denies wrongdoing The Spanish parliament held a plenary session on Thursday on the Bárcenas case, at the request of PM Mariano Rajoy himself. After reminding parliament that he does so voluntarily, and that parliament had no right to force him, he acknowledged that he made the error to trust someone whom he mistakenly believed to be innocent, in reference to former PP treasurer Luis Bárcenas. He said he supported Barcenas "as anyone who is a victim of persecution" until the discovery of Bárcenas' Swiss accounts at the end of last year. He also told parliament that the People's Party never kept a shadow accounting or covered up any crimes, but that "salaries", "complementary remunerations on account of a position" and "advances for expenses inherent to a position" were paid "as is done everywhere", above board and included in the official accounting. And he accused the opposition of trying to deflect from Spain’s economic success, as the recession is now ending. El País.that his own SMS to Barcenas contradicted his statement in parliament yesterday. PSOE leader Alfredo Pérez Rubalcaba asked the PM to resign, arguing that the publication of the SMS exchanges in which Rajoy tells Bárcenas "hang tough" and "we do what we can" after the Swiss accounts surfaced would have led to the resignation of a PM in Germany, France or the UK. ABC writes that PP MPs were "relieved" that Rajoy addressed the Bárcenas case directly without going on tangents as he had been doing so far, and concludes that Rajoy's position has been reinforced among his supporters. The issue may flare up again after the summer recess but Rajoy is likely to ignore it on the grounds that he already said all he had to yesterday, PP voters and supporters will no longer have the impression that Rajoy has been avoiding the issue for six months. The markets have so far taken little interest in the Bárcenas case, and yesterday bond market reaction was resoundedly positive, as yields came down further. Rajoy and his supporters are clearly hoping that the rebound of the economy would sweep the Barcenas case away as a political story. We doubt that. For once, the case is unusually serious, and more allegations are likely to surface as the trial goes under way. And while the Spanish recession may well in Q3 or Q4, the recovery is likely to be very shallow, given the financial devastation of the crisis. Irish coalition tensions over austerity Tensions are escalating in the Irish government between the two coalition government parties, Fine Gael and Labour, as their MPs clash over the fiscal plan for 2014, the Irish Times reports. A group of five Labour MPs launch a broadside in the newspaper today against “austerity junkies” on the other side of the Coalition. Their call for a softer budget in mid-October stands in marked contrast to demands from a group of eight Fine Gael MPs who insist that the Government must continue to exceed fiscal targets set by the troika of international lenders. This escalation comes against the backdrop that the troika recommended to proceed with a €3.1bn retrenchment to secure the smooth exit from the bailout programme. Senior labour figures object that further austerity “ignores the fact that taking more than is needed out of the economy will itself have a deflationary effect. “ These tensions foreshadow difficult negotiations as the budget 2014 is to be finalised by the Coalition immediately after the summer break.

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Greek civil servants on strike The civil servants’ union, ADEDY called out strikes for today after the government published yesterday the names of more than 2122 primary and secondary school teachers who will be transferred to the new mobility scheme, Kathimerini reports. The head of the Federation of Secondary School Teachers (OLME), Themis Kotsifakis, was among the teachers included in the ministry’s list. He called the ministry’s move a “crime” and made reference to a teacher in Larissa, central Greece, who reportedly died of a heart attack earlier this week after learning she would be transferred. Next to be published are some 3,000 municipal police officers, 1,500 administrative staff from universities and technical colleges, 1,500 public healthcare workers and 600 staff from various social security funds and the OAED manpower organization. The government has promised the troika it will have 12,500 civil servants in the scheme by September and 25,000 by the end of the year. The public sector workers will receive 75% of their salary for eight months until another position is found for them. If no position is found for them, they will be dismissed at the end of eight months. Brazil supports Greece aid programme after all Brazil’s finance minister Guido Mantega phoned Christine Lagarde expressing his support for the Greek aid programme, saying that its representative at the IMF Nogueira Batista had not consulted his government before the vote and was not authorised to withhold support for the latest aid to Athens, according to the FT. In Brazil Mantega’s rush to support the IMF’s decision is met with some disbelief, as Mantega used to be one of the starkest critics of the IMF. One analyst says it is a sign of his own political weakness. Batista had released a second, shorter statement on Wednesday, in what some saw as an attempt to mollify the public reaction to his first, in which he said although he represented other countries in the region, his decision to abstain from the latest vote on Greek aid should not be attributed to them. Lagarde confident that Europeans stand behind their commitment to Greece Christine Lagarde said she is confident about Europe's commitment to provide additional measures to help Greece reach the agreed debt thresholds if Greece delivers on its commitments. "I have no reasons to believe the Europeans would not themselves deliver on their undertaking vis-à-vis Greece," she told reporters on Thursday. "What form those further measures and assistance will take will certainly be discussed at a later stage." 70% of the French expect economy to deteriorate A recent CFA opinion poll for Les Echos showed that 70% of the French estimate that the economic situation in France is about to get worse. This contrasts with the optimism displayed by Francois Hollande during his interview on July 14, when he declared that "the recovery is here," based on some improved indicators. The majority is even larger, more than 75%, among workers and self-employed. The majority also holds through the different age groups. The only difference is with respect to parties. Only among Socialists, pessimism is a minority (36%) while 56% consider the situation stable. But only 11% of the Socialists would share Hollande’s optimism saying the situation is getting better. Among other left wing parties, pessimism is again the majority. On the right, the sentiment that the situation will get worse is overwhelming (86%) and quasi unanimous among Front National voters (92%). Pollsters explain this stark polarisation with the credibility the party supporters give to Francois Hollande’s assured optimism.

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Draghi’s cautious message This was clearly one of the less memorable meetings of the ECB’s governing council. There was no change in interest rates, as expected, and Mario Draghi did not get any more specific on time frame and conditionality for forward guidance. He said in his opening statement that the recent economic data “tentatively confirm the expectation of a stabilisation in economic activity at low levels. At the same time, labour market conditions remain weak.” Importantly, he also said the risks remained on the downside. He said recent developments in global money and financial market conditions had the potential to affect the economy negatively. Other downside risks included weaker than expected demand and insufficient implementation of structural reforms. The markets, however, are becoming less convinced that the ECB would cut interest rates again. Draghi also affirmed that he would present a proposal for a publication of minutes to the governing council in the autumn. He said he supported what he called “richer communication”, but said that the new strategy should protect the independence of council members. Welt says transparency bad for German savers One of the reasons why the Germans have such difficulty with the ECB right now is that their national debate has been exceptionalist for several decades. The proposals for central bank transparency came as a total shock – including for otherwise reasonable commentators like Mark Schieritz. Die Welt has a long article citing all the disadvantageous of minutes – that the debate into the corridors, that no one stands up to the governor, while the headline says bluntly that transparency was bad for German savers (which was never explained. We presume that a published commitment to keep interest rates low for an extended period would keep interest rates lower for longer than necessary, but we are not really sure.) While we do not believe that Fed or BoE style minute writing is such a big deal, we think it would be useful to have a more detailed rendition of the arguments, rather than just the distilled version presented at the press conference. We also think that voting records would be useful, but this is not likely to happen. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.566 0.559 0.551 Italy 2.749 2.693 2.671 Spain 2.955 2.922 2.901 Portugal 4.772 4.752 4.793 Greece 8.457 8.370 8.38 Ireland 2.229 2.217 2.198 Belgium 0.856 0.863 0.856 Bund Yield 1.669 1.67 1.692

Euro Bilateral Exchange Rate

Previous This morning

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Dollar 1.324 1.322

Yen 130.580 131.65

Pound 0.872 0.874

Swiss Franc 1.232 1.2383

ZC Inflation Swaps

previous last close

1 yr 1.45 1.46

2 yr 1.43 1.41

5 yr 1.58 1.6

10 yr 1.94 1.95

Euribor-OIS Spread

previous last close

1 Week -4.629 -5.629

1 Month -2.600 -3.6

3 Months 4.186 4.086

1 Year 31.343 29.943

Source: Reuters

http://www.eurointelligence.com/professional/briefings/2013-08- 02.html?cHash=d1a6047b391734ea5ba6e437942e3e0d

ft.com Comment Opinion

Last updated: August 1, 2013 12:37 pm Why Obama should pick Summers to lead the Fed By Bradford DeLong If times were normal, first choice among the Fab Five would be Yellen, writes Bradford DeLong

©Bloomberg After eight years as chair of the US Federal Reserve, Ben Bernanke is stepping down. Fairly soon, President Barack Obama will need to choose a successor – a decision that

120 will be among the most important that he will ever make. I believe he should be looking for a candidate who passes three tests. First, he must find someone with the right experience. They must have served in a similar role, and served with distinction. Washington is an unusual place, and its bureaucracies are unusual institutions. People appointed to high federal office can learn on the job. But it is better if the bulk of that learning takes place before one is chairing the Fed. More ON THIS STORY/Academics square up in fight for Fed/ Obama defends Summers to Democrats/ Raskin chosen for deputy treasury post/ Comment Hurdles next Fed chair must clear/ Mike Konczal Bernanke did well but Fed must do better IN OPINION/ Jonathan Ford Moral objections favour Wonga/ David King and Richard Layard We need a new Apollo to harness the sun/ Peter Tasker Japan needs reminding of its lost decade/ Hans-Joachim Voth and Mauricio Drelichman Banks should learn from Habsburg Spain Second, they must have the right values. Right now, America’s biggest economic problem is that employment is too low. In normal times there may be an argument that the Fed chair should care deeply about inflation and less so about other goals. But these times are not normal. The new chair must feel the pain of the unemployed in their viscera. Third, they must understand the right model of the economy. Since 2008, Mr Bernanke has worried too little about how spending might get trapped in a low-level vicious circle and how America might suffer from a prolonged jobless recovery. He has been continually surprised by growth, employment, and inflation outcomes – all of which have been constantly and consistently lower than he expected. A good candidate for the Fed will be someone who understands the Minskyite and Keynesian dimensions of the economy: that herding financiers can do truly remarkable amounts of damage through their exuberance and pessimism, and that the spending flows that determine production and employment do not rebalance themselves without government assistance. Five candidates are way above the rest: former Treasury Secretary Lawrence Summers; current Fed vice-chair Janet Yellen; former Fed vice-chair Alan Blinder; former Council of Economic Advisors chair Christina Romer; and former National Economic Council chair Laura Tyson. These are the Fabulous Five. Choosing any of them would make me happy. Choosing anybody else would be an unforced error. If times were normal, my first choice among the Fab Five would be obvious: Ms Yellen. Back in 1994, the Clinton administration pulled Ms Yellen out of the academy and on to the Fed. She was a brilliant choice, with a profound understanding of economics and a proven record as a consensus-builder. She is often the most insightful person in the room, but does not feel the need to constantly prove herself such – and she has a 15- year record of success in Washington. But these are not normal times. In normal times, the “short run” in which the economy remains below its normal relative level of activity is a year or so. It has been five years since we saw normality, and few would lay long odds that we will escape without a lost full decade.

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In normal times the Fed’s senior policy makers are economic priests following a settled gospel of technocratic economic management. But right now, as John Maynard Keynes said in a similar crisis in the 1920s: “no one has a gospel”. Therefore, Keynes said then, “the next move [must be] with the head ...” And the Fed, over the next four years, is the best place to do the thinking that must be done to recover and rebuild. And this is why my preference is for Mr Summers. He is the most creative thinker around. If I prepare for four hours for a one-hour discussion with Mr Summers, it takes him 15 minutes to get up to speed, for the next 30 minutes I am holding my own, and for the last 15 he is coming up with insights that I would have missed had I spent 12 hours thinking the issue through. Unless things start getting better faster, in a year or two it will be clear that the Fed’s current policy consensus is past its sell-by date. And in that case a lot of outside-the-box thinking will be called for. Could a Summers appointment be a mistake relative to a Yellen pick? Yes. If you told me that the next four years would be placid and that the current Fed consensus were close to optimal, would I still prefer Mr Summers? No. Would the Federal Open Market Committee be a calm and happy place under him? Unlikely, but it wasn’t calm and happy under Paul Volcker either. Does Mr Summers’ failure to maintain the confidence of the Harvard faculty when he was its president weigh against him? Yes. But does Mr Obama believe Mr Summers served him well as chair of his National Economic Council? Yes. So the benefits to that move of a Summers appointment do, I think, outweigh the risks. My preference for Mr Summers over Ms Yellen is a very narrow one. If I weighted consensus and creativity differently – as other people, quite reasonably, do – I would come out on the other side. And I think Ms Yellen would, in any case, be an excellent choice. Any of the five would. It’s just that I believe Mr Summers would be slightly more excellent.//The writer is a professor at the University of California, Berkeley http://www.ft.com/intl/cms/s/2/f816ea92-fa85-11e2-87b9- 00144feabdc0.html#axzz2ajGjOtuw

ft.com Comment Columnists

August 1, 2013 4:15 pm Britain is slamming its doors against the world

By Philip Stephens A champion of the liberal, open international system is redefining itself as a resentful victim

©Ingram Pinn

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Stop the world. Britain wants to jump off. The 2012 Olympics were a glorious celebration of diversity. London presented itself as an unrivalled global hub. The local heroes of the games – athletes such as Mo Farah and Jessica Ennis – testified to a new, expansive view of Britishness. That was then. A year on, the nation’s politics echo to the sound of doors slamming shut. The message to foreigners is depressingly simple: stay away. David Cameron’s Conservatives promise a referendum that could lead to Britain breaking off engagement with Europe. There was a time when these Tory sceptics presented a choice: give up Europe and look to the world. No longer. The barricades are being thrown up against all and sundry. Tourists, students, business executives – all are would-be illegal immigrants. More ON THIS STORY// Memo next steps on the ‘#RacistVan’/ Australia warns UK against EU exit/ Battle lines drawn over UK immigration/ UK visa system ‘letting executives down’/ EU-UK balance of powers broadly correct ON THIS TOPIC/ Doreen Lawrence to be awarded Labour peerage/ Cruddas wins damages from Sunday Times/ Compensation purge sparks MPs’ warning/ Media plan focuses on guarding consumer PHILIP STEPHENS/ In the Middle East, a decade of war promises a decade of disorder/ Facts finally collide with ideology on Europe/ Italy must throw out its racist politics/ China offers Brits a lesson in manners The other day, the Home Office, the department responsible for border controls, gave a glimpse of the nasty populism driving government policy. Trucks with billboards were deployed to London’s ethnically diverse areas. The message? Illegal immigrants should “go home or face arrest”. The Liberal Democrats, the junior party in Mr Cameron’s coalition, protested that the initiative was stupid and offensive. Unmoved, the prime minister’s office said the campaign might well go nationwide. The Home Office also plans to require visitors from “high risk” countries to pay a £3,000 cash bond to enter Britain. The aim, so it says, is to deter “overstaying” and to recover costs if visitors require healthcare. The countries chosen are India, Nigeria, Kenya, Pakistan, Sri Lanka and Bangladesh. It has not escaped their attention that predominantly “white” nations such as the US, Canada, Australia and New Zealand are exempt. Closer to home, the government is promising to restrict the access of Romanians and Bulgarians. Nationals from these EU states gain free movement across the union when transitional restrictions expire next year. Britain’s tabloid press is already full of horror stories about hordes of “benefit tourists”. Never mind that migrants are less likely to claim welfare than Brits. The government is playing to the populist gallery. The prime minister has jettisoned the “big society” inclusiveness he once counted his trademark. The pinched nationalists of the United Kingdom Independence party have outflanked the Tories on the right. Economic stagnation and fiscal austerity have stirred public resentments. Mr Cameron once called Ukip supporters “closet racists”. Now he courts them. The air of paranoia is stirred by pressure groups such as Migration Watch UK. Sir Andrew Green, the former diplomat who heads the organisation, holds up a study saying that “white British” (Sir Andrew’s phrase) could be a minority by the latter half of the century.

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Some of us ask: “so what”? When Farah and Ennis – the one from Somalia, the other of partly Caribbean heritage – were cheered to the rooftops, it seemed a fair assumption that Britain had left behind skin colour as a marker of national identity. I do not recall complaints they were “brown British” when they collected their gold medals. Alas, such triumphs do not puncture saloon bar xenophobia in the English home counties. Britain does need an intelligent and effective immigration policy. People want to see that the system is fair, efficient and not unduly disruptive of local communities. The last Labour government hopelessly underestimated the number of arrivals from former Communist states after their accession to the EU. An open-door policy combined with lax administration produced a widespread perception that immigration had run out of control. For the present government, however, moral panic and populist gestures have become a distraction from its own failure to grip the system. And how much easier it is to blame immigrants for filling jobs than to tackle the failures of a domestic education system that turns out so many unmotivated and unqualified young people. Only the other day, a committee of MPs said the official immigration count was anyway based on “guesses”. This is hardly surprising when there is no passport or visa check on departing visitors. These guesses say net immigration has fallen quite sharply. That is probably true. But the fall has been largely in response to a clampdown on the numbers of overseas students. Nations such as Canada, the US and Australia do not count students as permanent immigrants for the obvious reason that most return home. Meanwhile, Britain’s visa system is in disarray, entry controls at London’s Heathrow airport are a shambles and 300,000 asylum and immigration cases are unresolved. The official target to reduce net immigration to the low tens of thousands is riddled with contradictions. It assumes the number of entrants from Brazil or the US should rise and fall relative to how many Britons retire to the Spanish sunshine. If Polish plumbers go home, Britain can take more Indian engineers – and vice versa. Beyond such idiocies lies a much bigger danger. Britain was once a champion of the liberal, open international system. Now it is redefining itself to the world as a resentful victim. Moves to get out of Europe and bar immigrants speak of collapsing national confidence. And the economic consequences would be catastrophic. Why should any right-thinking business leader from, say, China, India or Brazil, invest in a country that denies them access to the EU and says their compatriots are unwelcome guests? Britain may be about to jump off, but the world will keep on turning. http://www.ft.com/intl/cms/s/0/8421e104-f9e1-11e2-98e0- 00144feabdc0.html#axzz2ajGjOtuw

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ft.com Comment Editorial

August 1, 2013 6:28 pm

Eurozone should relieve the IMF Time for Europe to shoulder burden of its own problems Once again, a review of the eurozone-International Monetary Fund rescue for Athens throws up an inconvenient truth. The fund is unconvinced that, on its current course, Greece will reach required fiscal targets. Rather than fudging their disagreement, Europe and the IMF should take the chance to recast the way they collaborate. The rationale for IMF participation was never financial, or should not have been. The eurozone’s penny-pinching attitude is unjustified by any inability to shoulder the cost of its own problems. The legitimate reason for bringing in the IMF was to draw on the fund’s expertise and proven ability to discipline the recipients of its credit. More ON THIS STORY/ U-turn as Brazil backs IMF aid for Greece/ Brazil hits out at IMF over Greek bailout/ IMF warns of €11bn Greek bailout shortfall/ In depth Greek debt crisis/ Global Insight Eurozone calm masks brewing political storm EDITORIAL/ Zero-hours workers/ Detroit Motown blues/ Multiple choice/Potash pricing This was the right idea. In practice, however, Europeans relegated the IMF to second fiddle, and the fund did not have the gumption to protest. But staff misgivings have risen to the surface, in part because the IMF may not lend to creditors without full financing for the coming year. The latest quarterly review suggests a financing gap of €11bn starting in late 2014, and a need for debt forgiveness to the tune of 4 per cent of output to reach levels deemed sustainable. One should not obsess over the numbers, which are quantitatively small but happen to make the difference between meeting an arbitrary target or not. But they must be made to add up. The recurring uncertainty about how to do this, and thus about the rescue programme’s future, has been a festering unforced error that worsens Greece’s suffering. Emerging powers’ growing unease about IMF exposure makes matters worse. So far, the eurozone has kept the IMF on board by promising – sotto voce to keep the discussion out of domestic political debates – to find ways to fill the financing gaps. Greece, the rest of the eurozone, and the IMF would all be better off if the uncertainty were removed once and for all. Europe could do this by buying the fund out: first, by stepping into the IMF’s share of future disbursements, then gradually, by taking over its outstanding exposure at par. If eurozone leaders asserting that the programme is working are to be taken at their word, this would not expose their taxpayers to any new risks. That by itself will not fix things. Athens’ European creditors may still have to reschedule its debt service – a way to lighten the burden on Greece without politically toxic nominal writedowns. But freeing the IMF from its dead marriage with Europe will make it easier for it to tell the truth as it sees it, and harder for the eurozone to ignore its own policy failures. http://www.ft.com/intl/cms/s/0/c4250650-faa4-11e2-a7aa- 00144feabdc0.html#axzz2ajGjOtuw

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Forget Larry Summers. What if Roger Ferguson took over the Fed? By Dylan Matthews, Updated: August 1, 2013 On Sept. 11, 2001, Roger Ferguson, the mild-mannered vice chairman of the Federal Reserve, found himself unexpectedly asked to play the role of first responder in what could’ve been a global financial meltdown. The World Trade Center housed some of the world’s most important banks and investment firms, and the terrorist attacks left southern Manhattan, the nation’s financial capital, in physical ruin. If the nation’s banking system were to freeze up, then the economic damage from the attacks also could have been monstrous. But then-Federal Reserve Chairman Alan Greenspan was on a flight back from Zurich and found himself grounded in Switzerland after the terrible event. The responsibility fell to Ferguson. Ferguson, by all accounts, nailed it. He issued a statement short enough to get through to people but clear enough that no one could mistake its meaning: “The Federal Reserve System is open and operating. The discount window is available to meet liquidity needs.” Banks took out $46 billion in emergency loans, 200 times the daily average before the attacks. He led briefings to organize the Fed banks across the country to work in concert to ensure that the human disaster of 9/11 did not also become a financial disaster. “He took charge without being in any way overbearing,” said William Poole, president of the St. Louis Fed at the time. “He was very competent under fire, and boy, if there was ever time when you’re under fire.” Now, as President Obama weighs who to name chairman of the Federal Reserve, Ferguson has unsurprisingly emerged as a top contender, particularly if frontrunners Larry Summers and Janet Yellen do not get the nod. Based on a review of his record and his recent public comments, and interviews with about a dozen people who have worked with him, Ferguson is a deliberative, thoughtful leader whose style tends to be more conciliatory than divisive, a particular contrast with Summers, who frequently finds himself in public and private scrapes. It is less clear whether Ferguson would be aggressive in regulating Wall Street or push the boundaries of monetary policy. It’s not even clear that he wants the job. (Ferguson declined to be interviewed through a spokesman for the financial services firm TIAA- CREF, where Ferguson is CEO.) Former colleagues are largely unanimous in describing him as an intelligent, decent man. “I have tremendous respect for him,” Poole says. “I always thought he was worth listening to.” He particularly has a track record of teaching and encouraging colleagues.

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“Those of us who joined the board under his vice chairmanship found him to be an enormously hands-on mentor,” Mark Olson, who served on the Fed board from 2001- 2006 says. “I think of Roger as one of the best mentors I’ve ever had.” And the president, it appears, also listens to him. Ferguson has visited the White House 14 times, often in relation to his role on the President’s Economic Recovery Advisory Board (PERAB) and its successor, the President’s Council on Jobs and Competitiveness. He was asked to submit his name for consideration for a high-level position when President Obama took office. A former administration official says that Ferguson became “someone that people at the White House and Treasury would view as a resource, someone you could go to who would give you the unvarnished truth.” But even as those who have worked with Ferguson think he’s more than able to take on the job, what he’d do in it is a bit of a mystery. No fan of targets His time at the Fed does provide some clues to his leanings, but colleagues say that it was hard to define his stand relative to other policymakers, particularly because the economy when he was at the Fed was so good. “There was actually not a lot of controversy about monetary policy, because things were going very well,” said Alice Rivlin another former Fed vice-chair. “Remember those Goldilocks years, when growth was high, unemployment was low, and inflation was coming down?” Monetary policy in good times is radically different from monetary policy in crisis. Interest rates were not hitting near zero; if the economy worsened, rates could go lower, and if inflation was a risk, they could go higher. Quantitative easing through bond- buying wasn’t necessary. Debates about whether to target inflation or nominal GDP were largely flights of fancy for academics rather than real discussions about how to save the world economy.

That said, you can still find some clues in Ferguson’s statements during that period. For one thing, he was skeptical of hard and fast targets for inflation, which has been a hallmark of the Bernanke Fed. In the mid-2000s, while Bernanke and Yellen backed an explicit

127 inflation target, Ferguson, along with Alan Greenspan and Donald Kohn (who succeeded Ferguson as vice chair), were skeptical, according to transcripts of Fed policy meetings from the era, arguing that setting an explicit target for inflation could hamper the bank’s flexibility. If Ferguson carries those views today, it suggests he may be less likely to give clear “forward guidance” about what the Fed will do than Ben Bernanke has been. It’s hard to imagine him declaring that the Fed would target 5 percent year-over-year growth in nominal GDP, for instance Yet his comments on quantitative easing, the vast purchases of bonds that the Fed has used as a major policy tool since cutting short-term interest rates to zero in 2008, suggest he would support the efforts the Bernanke Fed has undertaken. The Atlantic’s Matthew O’Brien notes that Ferguson signaled support for quantitative easing and for promises to keep interest rates low in 2003, exactly the same policy approaches adopted by Bernanke since the crisis hit. When the second round of quantitative easing launched in late 2010, Ferguson said on CNBC that he wasn’t sure it would work but that he thought it was worth a try. “On balance, I think the Fed is doing the right thing, and in that I’m in the same company as Chairman Bernanke and others,” he said. But he was clear that he thought there were risks, most notably that “inflation expectations suddenly pick up because the Fed is pumping so much money into the system; next thing you know you get interest rates that suddenly spike, and you get a contrary reaction, a reaction just the opposite of what the Fed is trying to do.” Ferguson still thought a positive U.S. economic response — like the one that actually occurred — was more likely. But even in the best-case scenario, he didn’t think QE would be a lifesaver: “Is it going to suddenly jumpstart growth so that next year is much better than this year? I don’t think so.” What’s more, in the past, he’s been very clear that he thinks “low and stable” inflation is a prerequisite to long-term growth. That’s at odds with the view, most prominently voiced by Harvard economist Kenneth Rogoff, that we might need 4 percent or even 6 percent inflation for a few years. On monetary policy, then, Ferguson appear broadly similar in approach to Bernanke. But he would probably be less willing to entertain exotic, unconventional targeting mechanisms like NGDP targeting, or even the unemployment rate threshold that Bernanke implemented last year. On the banks Then again, that may not be the most important issue in picking a Fed chair. “The mandate for watching out for systemic risk and the financial system is a much bigger mandate now than it was [when Ferguson was at the Fed],” says Alice Rivlin, who preceded Ferguson as Federal Reserve vice chair. “And I think Roger gets that. He’s focused on financial stability and on international aspects of it as well.” His role at TIAA-CREF gives him a unique perspective as someone from a major financial institution, but the firm doesn’t engage in the kind of trading that led to the financial crisis. PERAB, of which Ferguson was an influential member, was chaired by former Fed chairman Paul Volcker, who continues to advocate for the Volcker Rule. An administration official who was present during the Dodd-Frank discussions adds, “Because of his background in government and finance, Roger has a worldview that recognizes the relationship between policy and financial markets. This would certainly extend to regulation of the large financial institutions.”

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That said, Ferguson’s writings on financial regulation before the crisis — not to mention his time on the deregulation-minded Greenspan Fed — suggest he might not be the anti-bank crusader some progressives hope for. In April 2007, he argued that hedge funds did not add to overall systemic financial risk. “On balance…hedge funds enhance market stability and are unlikely to be the source of a systemic failure,” he concluded. While hedge funds did not lead to the financial crisis, that’s no guarantee they won’t be a danger going forward. In 2006, while still at the Fed, he spoke in glowing terms about financial consolidation and new derivatives markets, saying he was more optimistic about the latter than some critics. But he did have some sense of the dangers to come, and the need for bank supervision. “The central bank can assist in getting market participants to consider and focus on the management of risk in general and of the risk of low probability, but high cost, outcomes in particular,” he concludes. In 2003, he endorsed more stringent capital standards as a way of controlling the risk deriving from larger banks. “Capital standards provide an anchor for virtually all other supervisory and regulatory actions and can support and improve both supervisory and market discipline,” he concluded. In 2007, he suggested support for tightened regulation of rating agencies, which proved prescient. But his read on the derivatives markets was fairly rosy. “The financial community — broker/dealers, end users and regulators — has ably managed the development of the derivatives market in recent years,” he and his coauthors concluded. They took a “wait and see” approach to subprime mortgages. The crisis “has not yet brought any generalized fall in asset prices, a central feature of a true ‘financial crisis,’” they concluded. Of course, eventually, it would. More recent comments suggest Ferguson may still be fairly lax in his views on bank regulation. In an interview with CNBC earlier this year, Ferguson suggested he thinks self-regulation is called for. “Regulation is necessary, but not sufficient, and one should be looking to see how they improve their own behavior, their own risk management, and their own internal corporate governance,” he argued. An emphasis on “self- regulation” doesn’t augur well for any tough rules coming out of a Ferguson Fed. Would he even take it? Of course, there’s a question of whether Ferguson would even take a position. A senior administration official tells me that Ferguson was contacted about applying for a top position in the Obama administration in late 2008. But Ferguson declined to even fill out basic paperwork, citing his job at TIAA-CREF, which he had only recently taken. Another administration official says he was considered for a number of jobs — including head of the National Economic Council after Summers left — but the TIAA- CREF job kept getting in the way. “I just don’t think there is really a story here,” McPherson says. “Roger loves what he is doing, and he has said repeatedly to us and publicly that he wants to stay at TIAA- CREF for many years.” When Maria Bartiromo at CNBC asked if he’d take the Fed job, Ferguson laughed out loud, and added “I really love what I’m doing, I’m very committed to TIAA-CREF and our important mission of creating financial well-being for millions of Americans.” That’s not a firm denial, and Ferguson hasn’t really said “no.” But he does seem to genuinely like being in the private sector. That might explain why Obama mentioned Yellen, Summers, and Kohn in meetings with Congressional Democrats on Thursday,

129 rather than Ferguson. The fight for Fed chief shows no signs of dying down soon, though, and there may be many twists and turns to come. Don’t be surprised if they end up leading to Ferguson. http://www.washingtonpost.com/blogs/wonkblog/wp/2013/08/01/forget-larry-summers- what-if-roger-ferguson-took-over-the-fed/?wpisrc=nl_wnkpm

This graph calls the entire economic recovery into question By Ezra Klein, Updated: August 1, 2013 From the Center on Budget and Policy Priorities:

The core issue here is that the unemployment rate only counts people actively looking for work. That means there are two ways to leave the ranks of the unemployed. One way — the good way — is to get a job. The other way is to stop looking for work, either because you’ve retired, or become discouraged, or begun working off the books. The yellow line on the left shows the official unemployment rate since 2008. It’s fallen from over 10 percent to under 8 percent. But the red line on the right shows the actual employment rate — that is, the percentage of working-age adults with jobs. What should scare you is that the red line has barely budged. At the beginning of 2007, the employment rate was 63.3 percent, and the unemployment rate was 4.7 percent. By the end of 2009 — so, after the worst of the recession — it had fallen to 58.3 percent, and unemployment was up to 9.9 percent. Today, it’s 58.7 percent, even though unemployment has fallen to 7.6 percent. That means a lot of the people who’ve left the rolls of the unemployed haven’t gotten a new job. They’ve just left the labor force altogether. Some of that’s natural. The population is aging, and the labor force was expected to shrink. But it wasn’t expected to shrink this much. The economy is a lot worse than a glance at the unemployment rate suggests. And instead of doing anything to help those people get back to work, Washington canceled the payroll tax cut, permitted sequestration to go into effect, and is now arguing about whether to shut down the federal government — and possibly breach the debt ceiling — in the fall. http://www.washingtonpost.com/blogs/wonkblog/wp/2013/08/01/this-graph-calls-the- entire-economic-recovery-into-question/?wpisrc=nl_wnkpm

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Summer 2013 Journal of Economic Perspectives On-Line The Summer 2013 Issue of the Journal of Economic Perspectives is now available online. Like all issues of JEP back to the first issues in Summer 1987, it is freely available courtesy of the American Economic Association. I've been the managing editor of JEP since that first issue, so for me, it's issue #105. The issue has two main symposia: one has six papers with various perspectives on the top 1% of the income distribution; the other has four papers on what has happened with the euro. There's also a paper at the end about the legacy of John Maynard Keynes as a highly successful institutional investor, and my own "Recommendations for Further Reading" column. I'll post more about specific papers next week. For now, here are abstracts of the articles, with the article titles in boldface, and weblinks. Symposium: The Top 1 Percent "The Top 1 Percent in International and Historical Perspective," by Facundo Alvaredo, Anthony B. Atkinson, Thomas Piketty and Emmanuel Saez The top 1 percent income share has more than doubled in the United States over the last 30 years, drawing much public attention in recent years. While other English-speaking countries have also experienced sharp increases in the top 1 percent income share, many high-income countries such as Japan, France, or Germany have seen much less increase in top income shares. Hence, the explanation cannot rely solely on forces common to advanced countries, such as the impact of new technologies and globalization on the supply and demand for skills. Moreover, the explanations have to accommodate the falls in top income shares earlier in the twentieth century experienced in virtually all high-income countries. We highlight four main factors. The first is the impact of tax policy, which has varied over time and differs across countries. Top tax rates have moved in the opposite direction from top income shares. The effects of top rate cuts can operate in conjunction with other mechanisms. The second factor is a richer view of the labor market, where we contrast the standard supply-side model with one where pay is determined by bargaining and the reactions to top rate cuts may lead simply to a redistribution of surplus. Indeed, top rate cuts may lead managerial energies to be diverted to increasing their remuneration at the expense of enterprise growth and employment. The third factor is capital income. Overall, private wealth (relative to income) has followed a U-shaped path over time, particularly in Europe, where inherited wealth is, in Europe if not in the United States, making a return. The fourth, little investigated, element is the correlation between earned income and capital income, which has substantially increased in recent decades in the United States. Full-Text Access | Supplementary Materials

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"Defending the One Percent," by N. Gregory Mankiw

Imagine a society with perfect economic equality. Then, one day, this egalitarian utopia is disturbed by an entrepreneur with an idea for a new product. Think of the entrepreneur as Steve Jobs as he develops the iPod, J. K. Rowling as she writes her Harry Potter books, or Steven Spielberg as he directs his blockbuster movies. The new product makes the entrepreneur much richer than everyone else. How should the entrepreneurial disturbance in this formerly egalitarian outcome alter public policy? Should public policy remain the same, because the situation was initially acceptable and the entrepreneur improved it for everyone? Or should government policymakers deplore the resulting inequality and use their powers to tax and transfer to spread the gains more equally? In my view, this thought experiment captures, in an extreme and stylized way, what has happened to US society over the past several decades. Since the 1970s, average incomes have grown, but the growth has not been uniform across the income distribution. The incomes at the top, especially in the top 1 percent, have grown much faster than average. These high earners have made significant economic contributions, but they have also reaped large gains. The question for public policy is what, if anything, to do about it. Full-Text Access | Supplementary Materials

"It's the Market: The Broad-Based Rise in the Return to Top Talent," Steven N. Kaplan and Joshua Rauh One explanation that has been proposed for rising inequality is that technical change allows highly talented individuals, or "superstars" to manage or perform on a larger scale, applying their talent to greater pools of resources and reaching larger numbers of people, thus becoming more productive and higher paid. Others argue that managerial power has increased in a way that allows those at the top to receive higher pay, that social norms against higher pay levels have broken down, or that tax policy affects the distribution of surpluses between employers and employees. We offer evidence bearing on the different theories explaining the rise in inequality in the United States over recent decades. First we look the increase in pay at the highest income levels across occupations. We consider the income share of the top 1 percent over time. And we turn to evidence on inequality of wealth at the top. In looking at the wealthiest Americans, we find that those in the Forbes 400 are less likely to have inherited their wealth or to have grown up wealthy. The Forbes 400 of today also are those who were able to access education while young and apply their skills to the most scalable industries: technology, finance, and mass retail. We believe that the US evidence on income and wealth shares for the top 1 percent is most consistent with a "superstar"-style explanation rooted in the importance of scale and skill-biased technological change. It is less consistent with an argument that the gains to the top 1 percent are rooted in greater managerial power or changes in social norms about what managers should earn. Full-Text Access | Supplementary Materials "The Pay of Corporate Executives and Financial Professionals as Evidence of Rents in Top 1 Percent Incomes," by Josh Bivens and Lawrence Mishel The debate over the extent and causes of rising inequality of American incomes and wages has now raged for at least two decades. In this paper, we will make four

132 arguments. First, the increase in the incomes and wages of the top 1 percent over the last three decades should be interpreted as driven largely by the creation and/or redistribution of economic rents, and not simply as the outcome of well-functioning competitive markets rewarding skills or productivity based on marginal differences. This rise in rents accruing to the top 1 percent could be the result of increased opportunities for rentshifting, increased incentives for rent-shifting, or a combination of both. Second, this rise in incomes at the very top has been the primary impediment to having growth in living standards for low- and moderate-income households approach the growth rate of economy-wide productivity. Third, because this rise in top incomes is largely driven by rents, there is the potential for checking (or even reversing) this rise through policy measures with little to no adverse impact on overall economic growth. Lastly, this analysis suggests two complementary approaches for policymakers wishing to reverse the rise in the top 1 percent's share of income: dismantling the institutional sources of their increased ability to channel rents their way and/or reducing the return to this rent-seeking by significantly increasing marginal rates of taxation on high incomes. Full-Text Access | Supplementary Materials "Income Inequality, Equality of Opportunity, and Intergenerational Mobility," Miles Corak My focus is on the degree to which increasing inequality in the high-income countries, particularly in the United States, is likely to limit economic mobility for the next generation of young adults. I discuss the underlying drivers of opportunity that generate the relationship between inequality and intergenerational mobility. The goal is to explain why America differs from other countries, how intergenerational mobility will change in an era of higher inequality, and how the process is different for the top 1 percent. I begin by presenting evidence that countries with more inequality at one point in time also experience less earnings mobility across the generations, a relationship that has been called "The Great Gatsby Curve." The interaction between families, labor markets, and public policies all structure a child's opportunities and determine the extent to which adult earnings are related to family background -- but they do so in different ways across national contexts. Both cross-country comparisons and the underlying trends suggest that these drivers are all configured most likely to lower, or at least not raise, the degree of intergenerational earnings mobility for the next generation of Americans coming of age in a more polarized labor market. This trend will likely continue unless there are changes in public policy that promote the human capital of children in a way that offers relatively greater benefits to the relatively disadvantaged. Full-Text Access | Supplementary Materials "Why Hasn't Democracy Slowed Rising Inequality?" by Adam Bonica, Nolan McCarty, Keith T. Poole and Howard Rosenthal During the past two generations, democratic forms have coexisted with massive increases in economic inequality in the United States and many other advanced democracies. Moreover, these new inequalities have primarily benefited the top 1 percent and even the top .01 percent. These groups seem sufficiently small that economic inequality could be held in check by political equality in the form of "one person, one vote." In this paper, we explore five possible reasons why the US political system has failed to counterbalance rising inequality. First, both Republicans and many Democrats have experienced an ideological shift toward acceptance of a form of free

133 market capitalism that offers less support for government provision of transfers, lower marginal tax rates for those with high incomes, and deregulation of a number of industries. Second, immigration and low turnout of the poor have combined to make the distribution of voters more weighted to high incomes than is the distribution of households. Third, rising real income and wealth has made a larger fraction of the population less attracted to turning to government for social insurance. Fourth, the rich have been able to use their resources to influence electoral, legislative, and regulatory processes through campaign contributions, lobbying, and revolving door employment of politicians and bureaucrats. Fifth, the political process is distorted by institutions that reduce the accountability of elected officials to the majority and hampered by institutions that combine with political polarization to create policy gridlock. Full-Text Access | Supplementary Materials Symposium: The Euro "What Is European Integration Really About? A Political Guide for Economists," by Enrico Spolaore Europe's monetary union is part of a broader process of integration that started in the aftermath of World War II. In this "political guide for economists," we look at the creation of the euro within the bigger picture of European integration. How and why were European institutions established? What is European integration really about? We address these questions from a political-economy perspective, building on ideas and results from the economic literature on the formation of states and political unions. Specifically, we look at the motivations, assumptions, and limitations of the European strategy initiated by Jean Monnet and his collaborators of partially integrating policy functions in a few areas with the expectation that more integration will follow in other areas in a sort of chain reaction toward an "ever-closer union." The euro with its current problems is a child of that strategy and its limits. Full-Text Access | Supplementary Materials "Political Credit Cycles: The Case of the Eurozone," by Jesús Fernández- Villaverde, Luis Garicano and Tano Santos We study the mechanisms through which the entry into the euro delayed, rather than advanced, key economic reforms in the eurozone periphery and led to the deterioration of important institutions in these countries. We show that the abandonment of the reform process and the institutional deterioration, in turn, not only reduced their growth prospects but also fed back into financial conditions, prolonging the credit boom and delaying the response to the bubble when the speculative nature of the cycle was already evident. We analyze empirically the interrelation between the financial boom and the reform process in Greece, Spain, Ireland, and Portugal and, by way of contrast, in Germany, a country that did experience a reform process after the creation of the euro. Full-Text Access | Supplementary Materials "Cross of Euros," Kevin H. O'Rourke and Alan M. Taylor The eurozone currently confronts severe short-run macroeconomic adjustment problems and a deficient institutional architecture that has to be reformed in the longer run. Europe's efforts at economic and monetary union are historically unprecedented. However, the gold standard provides lessons regarding what will and won't work, macroeconomically and politically, in the short run, while US history provides long-run

134 lessons regarding appropriate institutional structures. The latter also suggests that institutional reform only happens at times of great crisis, and that it cannot be taken for granted. The eurozone's leaders may therefore ultimately have to take heed of the lessons of history regarding currency union breakups. Full-Text Access | Supplementary Materials "Downward Nominal Wage Rigidity and the Case for Temporary Inflation in the Eurozone," by Stephanie Schmitt-Grohé and Martin Uribe Since the onset of the Great Recession in peripheral Europe, nominal hourly wages have not fallen from the high levels they had reached during the boom years -- this in spite of widespread increases in unemployment. This observation evokes a well-known narrative in which nominal downward wage rigidity is at the center of the current unemployment problem. We embed downward nominal wage rigidity into a small open economy with tradable and nontradable goods and a fixed exchange-rate regime. In this model, negative external shocks cause involuntary unemployment. We analyze a number of national and supranational policy options for alleviating the unemployment problem caused by the combination of downward nominal wage rigidity and a fixed exchange-rate regime. We argue that, in spite of the existence of a battery of domestic policies that could be effective in solving the unemployment problem, it is unlikely that a solution will come from within national borders. This leaves supranational monetary stimulus as the most compelling avenue out of the crisis. Our model predicts that full employment in peripheral Europe could be restored by raising the euro area annual rate of inflation to about 4 percent for the next five years. Full-Text Access | Supplementary Materials Features "Retrospectives: John Maynard Keynes, Investment Innovator," by David Chambers and Elroy Dimson John Maynard Keynes made a major contribution to the development of professional investment management. Based on detailed archival research at King's College, Cambridge, we describe Keynes' investment philosophy, his investment performance, and the evolution of his investment approach as the manager of a large educational endowment. His portfolios were actively managed and unconventional. He was an investment innovator both in making a substantial allocation to the then new institutional asset class of common stocks as well as in championing value investing. Full-Text Access | Supplementary Materials "Recommendations for Further Reading," by Timothy Taylor Full-Text Access | Supplementary Materials Notes and Errata Full-Text Access | Supplementary Materials Número completo: http://www.aeaweb.org/articles.php?doi=10.1257/jep.27.3 http://conversableeconomist.blogspot.com.es/2013/08/summer-2013-journal-of- economic.html

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Report| McKinsey Global Institute Game changers: Five opportunities for US growth and renewal July 2013 | bySusan Lund, James Manyika, Scott Nyquist, Lenny Mendonca, and Sreenivas Ramaswamy The US economy is struggling to find a new formula for vigorous growth. But all growth opportunities are not created equal. New McKinsey research pinpoints five catalysts—in energy, trade, technology, infrastructure, and talent development—that can quickly create jobs and deliver a substantial boost to GDP by 2020. An animated video below also runs the numbers on these game changers and frames the challenge for business and government to make the most of the opportunity. Exhibit Five US game changers could substantially boost GDP.

Four years after the official end of the Great Recession, US economic growth remains lackluster. But there is more at work here than simply the business cycle: strains in the labor market were apparent long before 2008. Today, labor-force participation is at a 34-year low, and the United States has two million fewer jobs than it did when the

136 recession began. Weak investment, demographic shifts, and a slowdown in productivity growth are dampening the economy’s trajectory. But the United States does not have to resign itself to sluggish growth. Game changers: Five opportunities for US growth and renewal, a new report from the McKinsey Global Institute (MGI), identifies specific catalysts that can add hundreds of billions of dollars to annual GDP and create millions of new jobs by 2020. To identify these catalysts, MGI looked for developments that are poised to achieve scale immediately and could accelerate growth across multiple sectors by 2020. We also focused on areas with an immediate window for action. Game changers zeroes in on five mutually reinforcing opportunities: • Shale-gas and -oil production. Powered by advances in horizontal drilling and hydraulic fracturing, the production of domestic shale gas and oil has grown more than 50 percent annually since 2007. The shale boom could add as much as $690 billion a year to GDP and create up to 1.7 million jobs across the economy by 2020. The impact will extend to energy-intensive manufacturing industries and beyond. The United States now has the potential to reduce net energy imports to zero—but only if it can successfully address the associated environmental risks. • US trade competitiveness in knowledge-intensive goods. The United States is one of the few advanced economies running a trade deficit in knowledge- intensive industries. But changing factor costs, a rebound in demand, and currency shifts are creating an opening to increase US production and exports of knowledge-intensive goods, such as automobiles, commercial airliners, medical devices, and petrochemicals. By implementing five strategies to boost competitiveness in these sectors, we believe the United States could reduce the trade deficit in knowledge-intensive industries to its 2000 level or close it— which would add up to $590 billion in annual GDP by 2020 and create up to 1.8 million new jobs. • Big-data analytics as a productivity tool. Sectors across the economy can harness the deluge of data generated by transactions, medical and legal records, videos, and social technologies—not to mention the sensors, cameras, bar codes, and transmitters embedded in the world around us. Advances in computing and analytics can transform this sea of data into insights that create operational efficiencies. By 2020, the wider adoption of big-data analytics could increase annual GDP in retailing and manufacturing by up to $325 billion and save as much as $285 billion in the cost of health care and government services. • Increased investment in infrastructure, with a new emphasis on productivity. The backlog of maintenance and upgrades for US roads, highways, bridges, and transit and water systems is reaching critical levels. The United States must increase its annual infrastructure investment by one percentage point of GDP to erase this competitive disadvantage. By 2020, that could create up to 1.8 million jobs and boost annual GDP by up to $320 billion. The impact could grow to $600 billion annually by 2030 if the selection, delivery, and operation of infrastructure investments improve. • A more effective US system of talent development. The nation’s long-standing advantage in education and skills has been eroding, but today real improvements are within reach. At the postsecondary level, expanding industry-specific

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training and increasing the number of graduates in the fields of science, technology, engineering, and math could build a more competitive workforce. At the K–12 level, enhancing classroom instruction, turning around underperforming high schools, and introducing digital learning tools can boost student achievement. These initiatives could raise GDP by as much as $265 billion by 2020—and achieve a dramatic “liftoff” effect by 2030, adding as much as $1.7 trillion to annual GDP. These opportunities can have immediate demand-stimulus effects that would get the economy moving again in the short term and also have longer-term effects that would build US competitiveness and productivity well beyond 2020. Taking action now could mark a turning point for the US economy and drive growth and prosperity for decades to come. About the authors Susan Lund is a principal at the McKinsey Global Institute, where James Manyika is a director; Scott Nyquist is a director in McKinsey’s Houston office; Lenny Mendonca is a director in the Washington, DC, office. http://www.mckinsey.com/insights/americas/us_game_changers?cid=other-eml-nsl- mip-mck-oth-1308

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07/31/2013 02:37 PM Crisis of Faith Doubts Grow Over Spanish Reforms By Martin Hesse Measures to pull Spain out of the crisis are failing to bear fruit and exacerbating social tensions. While some are optimistic, the core problems remain, and many are questioning the old elite's ability to clean up the financial sector and reform the country.

DER SPIEGEL Banking and Public Debt Problems in Spain Belén Romana merely has to step out of her office and into the street to be reminded of the battle she is waging. Outside, at the end of Madrid's Paseo de la Castellana, the two slanted office towers owned by the Bankia conglomerate jut into the sky. They have become a symbol of the crash in the Spanish real estate and savings bank sector -- as well as of the entire country's dire problems. Romana's job is to dispose of the remains. She is the head of Sareb, a so-called bad bank onto which eight Spanish lenders were allowed to unload more than €30 billion ($40 billion) in real estate and loans last winter. This toxic legacy of debt is supposed to be paid off over the next 15 years. The reorganization of Spain's financial sector is seen as the most important part of the reforms introduced by conservative Prime Minister Mariano Rajoy to overcome his country's economic and debt crises. But whether the plan will succeed remains uncertain, as real estate prices continue to slide amid continued concerns over the country's financial institutions. There are also growing doubts about Rajoy's abilities as a crisis manager. A corruption scandal surrounding Luis Bárcenas, the former treasurer of the governing People's Party party, is a reminder to Spaniards of how a group of political and economic elites has taken the country to the brink of ruin. Bárcenas has admitted to maintaining a network of illicit accounts filled with money from various individuals, including developers, who made substantial donations to the party and its officials in return for lucrative contracts. It was this climate that allowed real estate prices to become more and more inflated. But now the past is also catching up to Rajoy. "Chin up!" and "Stay strong!" he allegedly

139 wrote in text messages to the man in charge of the illicit accounts, even long after Bárcenas' intrigues had been exposed. Political commentators in Madrid are beginning to question the strength of Rajoy, who is scheduled to appear before parliament this week to face questions over the corruption scandal.

At any rate, crisis management is not getting any easier for Rajoy. Only about 30 percent of the electorate still supports his government's policies. Although there have been some successes, a number of reforms have been ill-conceived and only exacerbated societal divisions. Unemployment stands at 27 percent, and 2 million Spaniards get their meals from soup kitchens operated by social welfare organizations. "Spain has three core problems," says Clemens Fuest, head of the Center for European Economic Research (ZEW) in the western German city of Mannheim, "the extremely overinflated construction and real estate sector, the ailing banks and rapidly growing government debt." All three problems are closely related. Public debt is growing because the economy isn't gaining momentum. This can be partially attributed to the fact that the banks aren't lending enough money because they are still struggling with consequences of the precipitous end of the construction boom. A Precarious Position for Banks Under these conditions, the expectations placed on Belén Romana are very high. The economist, who is seen as a miracle weapon of sorts, is a confidante of Minister of Economy Luis de Guindos and was a potential candidate for various top EU posts before she took over the helm at Sareb. As the president of a bad bank, she prefers to keep a low profile. Sareb is one instrument to restructure the financial sector and reinvigorate the economy, but not the only one, Romana says. But the bad bank could also make the problems even worse. If

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Romana sells the old debt for too little, it would probably push real estate prices even lower and generate new losses for the banks. This leads her to downplay her influence. "We don't move the markets," she says.

But experts view things differently. "Sareb exerts a great deal of influence on prices in the real estate market," says Pablo Campos of the management consulting firm Oliver Wyman. For this reason, he explains, the bad bank will "do everything in its power to ensure that the first major sale is a success, so as to avoid sending a negative signal to the market." In the near future, Sareb hopes to successfully pull off "Project Bull," a deal involving up to 1,000 condominiums in the southern region of Andalusia and around the eastern city of Valencia. The pressure to succeed has been growing since the International Monetary Fund (IMF) accused Sareb of taking too optimistic a view of price trends in the housing market. Now the entire selling strategy may have to be revised. "It's possible that Sareb will lose money in the first year," Romana concedes. "But there will be enough capital." Still, what happens when the truly difficult cases come up for sale? It's hard to say how great the risks accumulated within the bad bank are. Since it is formally not a bank, Sareb is not subject to banking regulations. Taxpayers are also likely to be chagrined that Sareb gave financial institutions short-term bonds, primarily at attractive interest rates and guaranteed by the state, in return for their hard-to-sell assets. What's more, banks and investors are the majority shareholders of the bad bank, which, for the government, has the appeal that Sareb's debts do not appear on its balance sheets. But the IMF is concerned that this construct holds potential conflicts of interest for the private owners. No matter how much the government has bent over backwards to unburden the banks, they are still at risk. Two years of recession have wreaked havoc on Spanish companies, and the number of loan defaults is steadily rising. "If the country remains in recession

141 for another year, more banks will be in trouble," says Federico Steinberg, an economist at the Real Instituto Elcano (RIE), in Madrid.

Although the banks have been stabilized for the moment, Steinberg says, they are providing the economy with too little credit. And although they can borrow unlimited amounts of money at extremely low interest rates from the European Central Bank (ECB), "the aid from the ECB doesn't reach companies and households," says Paloma López. "It only helps the banks." Optimism amid a Sea of Troubles López is part of the leadership of the CCOO trade union. In her simple office on the edge of downtown Madrid, the energetic woman is settling scores with crisis management. The government knows about nothing but austerity, she says. By strangling demand, it has only prolonged the crisis. In her view, labor market reforms have failed to address the core of the problem: the concentration of the economy in the construction and real estate sector. "You can't export houses," López dryly notes. Still, Spain is in a better position to overcome the crisis than neighboring Portugal. The country is the home of international corporations. The telecommunications company Telefónica is currently attempting to take over German mobile wireless provider E-Plus. The construction company ACS has purchased a majority stake in the German construction giant Hochtief, and the Santander Group of banks is reportedly interested in Commerzbank, Germany's second-largest bank. But Telefónica and ACS are also battling large debts and, what's more, these companies make up only a small segment of the Spanish economy. "Spain's export industry is as competitive as Germany's," says Steinberg, the RIE economist. "But it is made up of fewer large companies." In his view, the country lacks an effective policy to make the many smaller companies more competitive.

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The reforms are often short on detail, resulting in a lack of coordination among various measures. For example, the government had hoped to boost labor market flexibility by relaxing protections against dismissal. But Spanish workers are also not mobile because there are so few affordable rental apartments. And as they try to reorganize their finances, many municipalities are even selling off low-income housing units, which only exacerbates the problem.

Sometimes the government's reforms are so half-baked that the courts turn around and invalidate them. In the spring, the European Court of Justice determined that Spanish eviction cases violated EU law, prompting the government to try to remedy the situation. But in doing so, it set such short deadlines for appealing eviction decisions that lawyers for the affected challenged the new regulations, as well. "The law is unconstitutional," says Edurne Irigoyen, who fights for the rights of the citizens affected by the evictions. The austerity policy and reforms mostly affect the poorest of the poor, she continues, while tax evaders are left unharmed and corruption still goes unpunished. Even the European Commission, which mandated the reforms, criticized poverty and social marginalization in a recent report. "The impact and acceptance of the reforms could increase if the government would save less on education and health, for example, and give targeted incentives for demand," says Steinberg, the RIE economist. Spain is significantly below the EU average when it comes to investments in education. Despite all the deficiencies, officials at the Ministry of Economics are optimistic. "The worst is behind us," says State Secretary Fernando Jiménez Latorre. He expects Spain to escape the recession in the second half of this year, even though the economy shrank by 0.1 percent in the second quarter. In any case, what is still growing is debt. In Spain and the entire euro zone, it reached a new high last week. At 88 percent of GDP, the Spanish debt ratio is admittedly only

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somewhat higher than Germany's. But Belgium and Ireland are still the only other EU countries where the national debt has recently grown more quickly.

Translated from the German by Christopher Sultan URL: • http://www.spiegel.de/international/europe/doubt-grows-in-reforms-of-rajoy- government-in-spain-a-913866.html Related SPIEGEL ONLINE links: • Photo Gallery Corruption Trial Adds to Spain's Woes http://www.spiegel.de/fotostrecke/fotostrecke-99698.html • Basta 'La Casta' No End in Sight to Italy's Economic Decline (07/24/2013) http://www.spiegel.de/international/europe/0,1518,912716,00.html • Rajoy's Successor? The Most Powerful Woman in Spanish Politics (07/23/2013) http://www.spiegel.de/international/europe/0,1518,912554,00.html • Going, Going, Gone Crisis-Plagued Madrid Sells Out (07/18/2013) http://www.spiegel.de/international/business/0,1518,911438,00.html • Debt Paralysis Can Austerity Alone Save Portugal? (07/17/2013) http://www.spiegel.de/international/europe/0,1518,911154,00.html • 'A Toxic System' Why Austerity Still Isn't Working in Greece (07/09/2013) http://www.spiegel.de/international/europe/0,1518,910078,00.html • Downward Spiral Southern Europe Remains Stuck in Crisis (07/03/2013) http://www.spiegel.de/international/europe/0,1518,908856,00.html • Viva la Siesta Should Southern Europe Really Be More German? (06/28/2013) http://www.spiegel.de/international/europe/0,1518,908109,00.html

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07/30/2013 10:36 PM Invisible Steinbrück Is the SPD Hiding Its Chancellor Candidate? By Annett Meiritz Peer Steinbrück launched the most important part of his campaign on Tuesday in an effort to boost his candidacy and his troubled party, the Social Democrats. But he still hasn't solved his biggest problem -- an inability to differentiate himself from incumbent Chancellor Angela Merkel. In Germany, the main stretch of the election campaign, usually just the last few weeks before the election, is referred to as the heisse Phase -- the hot phase. With Angela Merkel's main challenger for the office of chancellor lagging behind the conservative in polls, Social Democrat Peer Steinbrück hit the campaign trail much earlier than usual on Tuesday. "So far we've been at training camp," Steinbrück told reporters. "But tomorrow we will take to the streets." At a press conference in Berlin, he also presented the SPD's first campaign posters. Oddly, the party's chancellor candidate himself is missing from the images. The campaign posters shed light on some of the issues that are emerging as leading concerns for voters as they head to the ballot box on Sept. 22. One shows a family standing next to moving boxes expressing their wish for more modest rents in a country that has seen significant rent increases in many urban areas in recent years. Another shows a carpenter and a cleaning lady both pleading for a national minimum wage, which doesn't exist in many industries in Germany. Yet another shows a mother with a multiethnic child calling for more day care slots -- also a hot-button topic right now. All feature the party's election year slogan: "We Decide Together." The party plans to post around 8,000 of the signs across Germany. In some towns, small images of Steinbrück announcing dates for nearby stump speeches will be affixed to the posters. For the most part, however, his visage will be absent. Is it a sign that the SPD is somehow ashamed of candidate Steinbrück, who has failed to gain traction with his campaign and has suffered some embarrassing gaffes along the way? It's the kind of conclusion the SPD leadership would heatedly deny. Instead they argue they are playing down Steinbrück's image as a deliberate campaign strategy -- one aimed at focusing on issues and differentiating itself from the personality-driven approach adopted by the Merkel camp. That, at least, is the official line. With seven weeks left to go before election day, the SPD is kicking its campaign into high gear very early by German standards. Chancellor Merkel will be away on vacation until mid-August and the SPD wants to take advantage of the time to gain ground. Steinbrück has planned around 100 public appearances -- an average of two per day between now and Sept. 22. During the second and third phases of the campaign, the party plans to release new posters -- including ones that feature Steinbrück's face. A spokesman for the party said the SPD is in no way trying to hide or down play its candidate for the Chancellery.

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At the press conference in Berlin, Steinbrück addressed major issues important to the SPD with which he hopes to secure a lead in opinion polls -- subjects like bottlenecks in public investment, an urgently needed expansion of Germany's broadband Internet infrastructure, increases in wages and old-age poverty. All these issues have featured prominently in the news in recent months. Getting with the People But Steinbrück also doesn't want to come across as being too stodgy. This week, Steinbrück even visited a student flatshare in Berlin. He wore a polo shirt, sprawled out on a sofa and sipped beer with the college students, with reporters from the city's tabloid newspapers in tow. On Tuesday, Steinbrück said he had been pleased that the students used channels like Twitter and Instagram to highlight his visit. Tuesday's SPD press conference also made clear that the party is adopting negative campaigning as a key strategy and plans to go on the offensive against incumbent Merkel. Steinbrück ridiculed Merkel's pledge to introduce limits on rent increases, saying the chancellor discovered the pet issue four years after the SPD had announced its own similar policy. When it comes to political policies, Steinbrück said, Merkel's government -- a coalition of her conservative Christian Democrats and the business- friendly Free Democratic Party -- had a talent for producing "empty bottles with attractive labels." That kind of frontal attack can also be seen in the SPD's campaign posters, two of which feature the image of Chancellor Merkel. One features Merkel leaning over and shuffling through the contents of her handbag. It reads: "Privacy -- uncharted territory for Merkel," a jab at Merkel's much-maligned early response to the NSA spying scandal given during US President Barack Obama's visit to Berlin in June. At a joint press conference, Merkel described the Internet as "uncharted territory." Another campaign posters shows Merkel together with her chief of staff Ronald Pofalla and Defense Minister Thomas de Maizière (both also members of her CDU) with the question, "Merkel's expert team?" Pofalla, as chief of staff and head of the Chancellery, is also the German government's coordinator for intelligence matters, and currently faces difficult questions about cooperation between the country's intelligence agencies and the NSA, which SPIEGEL recently reported conducts surveillance on up to a half- billion communications connections in Germany each month. De Maizière, meanwhile, is under fire for delays and cost overruns on major military procurement projects including a drone that had to be abandoned at a cost of more than €500 million to German taxpayers. Still, the very fact that the SPD, which is traditionally one of Germany's two main political parties, believes it will have better prospects by focusing on the competition's weaknesses rather than the strengths of its own candidate is a telling sign of the party's diminished standing. SPD to Visit 5 Million Households Steinbrück is now seeking to position himself as a more approachable candidate. He's embarking on his "Straight Talk" tour of the country to engage in a direct discussion with the public. The SPD lost half of its voter base between 1998 and 2009, with the rise of the Left Party, which stole many of its left-wing voters after former SPD leader Oskar Lafontaine abandoned the party, and increased support for the Green Party. This

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year, it is putting all of its resources into winning voters back. An army of campaign volunteers plan to visit an astounding 5 million households across the country between now and election day in an effort to persuade undecided voters. The SPD candidate says his campaign schedule is so packed that he won't even have time for exercise between now and September. The best he can hope for is that sleep and good food will counter the stress of a brutal campaign regiment. Despite valiant efforts, though, it may be difficult for the SPD to overcome its greatest challenge -- that of differentiating itself from Merkel and her conservatives. The problem is that Merkel has already stolen many of the SPD's core issues right out from underneath the party. Be it child care, rent control, dialogue with the citizens or the euro crisis, Merkel's positions do not differ significantly from those of the SPD -- and this has not been lost on voters. The only issue where the SPD is in a strong position to attack has been on the NSA scandal, but even there voters simply aren't biting. The SPD is failing to catch up to Merkel's conservatives in the polls. So Steinbrück tried to do a little of everything on Tuesday. The campaign posters are also indicative of that. Closing his presser on Tuesday, Steinbrück had a few thoughtful words for his colleague Matthias Platzeck, the governor of the eastern state of Brandenburg who announced he would step down from office after suffering a minor stroke. "Decisions like that are very personal ones," Steinbrück said. "But there is life after politics." That idea might provide some consolation for the SPD chancellor candidate as well: Life still continues after the campaign. URL: • http://www.spiegel.de/international/germany/peer-steinbrueck-the-invisible-german- chancellor-candidate-a-913982.html Related SPIEGEL ONLINE links: • Steinbrück to Students: Pot Should Be Decriminalized (07/30/2013) http://www.spiegel.de/international/germany/0,1518,913881,00.html • PR Tricks Berlin Leaves Biggest NSA Questions Unanswered (07/29/2013) http://www.spiegel.de/international/world/0,1518,913635,00.html • Cover Story How the NSA Targets Germany and Europe (07/01/2013) http://www.spiegel.de/international/world/0,1518,908609,00.html • Ailing Infrastructure Scrimping Threatens Germany's Future (06/27/2013) http://www.spiegel.de/international/germany/0,1518,907885,00.html • Gaffe Gone Viral Merkel Mocked for Calling Internet 'Neuland' (06/20/2013) http://www.spiegel.de/international/germany/0,1518,906859,00.html • Campaign Headache Drone Debacle Could Cost Merkel a Minister (05/28/2013) http://www.spiegel.de/international/germany/0,1518,902132,00.html • Amateur Hour at the SPD Merkel Challenger Steinbrück Fails to Find His Feet (01/08/2013) http://www.spiegel.de/international/germany/0,1518,876157,00.html • Squeezed Out Rocketing Rents Become Election Issue in Germany (01/02/2013) http://www.spiegel.de/international/germany/0,1518,875224,00.html • Pension Armageddon Germans Fear Poverty Even After Life of Work (09/13/2012) http://www.spiegel.de/international/germany/0,1518,855352,00.html • All Work and Low Pay Getting By Without Minimum Wage in Germany (05/14/2012) http://www.spiegel.de/international/germany/0,1518,832724,00.html

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ft.com Markets Capital Markets July 31, 2013 11:05 am Standard Life warns over UK leaving EU By Ralph Atkins in London A UK exit from the EU would deal a “very, very substantial blow” to London’s standing as a global markets hub and Europe’s financial capital, the head of one of the country’s top asset managers has warned. Keith Skeoch, chief executive of Standard Life Investments, said in a Financial Times interview that it was “absolutely important that we’re at the heart of things and we do our level best to influence the European agenda”. More ON THIS STORY/ Interview Standard Life chief warns on crisis action/ Standard Life results highlight transformation/ Asset managers set to go for growth/ Standard Life pays top trio £10m in bonuses/ Pru poaches Standard Life executive ON THIS TOPIC/ Return to form for risk-taker IN CAPITAL MARKETS/ US Treasury announces cut in debt sales/ Fresh signs of life in Asia debt markets/ Carlyle prepares boom-era securities sale/ China injects funds into money markets, quelling fears His forthright comments point to an increased willingness by senior City figures to speak out in favour of the UK’s continued membership of the EU, even at the risk of creating political controversy. They could add to the pressure on the UK’s ruling Conservative party, which wants a referendum on the issue. London has faced recent warnings from Japan and Australia that a UK exit would hit its economic standing and cost jobs. Mr Skeoch warned that it was particularly important for the UK to play its role in European policy discussions given the sensitivity of its economy to world capital flows. “The only other European country that is more exposed than us is Luxembourg.” The UK’s exit “could be a very, very substantial blow to London, which remains at the heart of European and global capital markets”. In his interview, Mr Skeoch urged regulators and politicians to push for an “equity culture” across Europe, arguing that increased supplies of risk-bearing finance were essential to encourage investment and economic growth over the long term. Europe’s economy was far too dependent on bank finance, which lay at the heart of the global economic crisis. He said: “Policy makers need to be thoughtful about the relative cost of debt and equity and the tax advantages of debt relative to equity. We are in danger of seeing a substantial reduction in the supply of funds that provide risk-bearing, loss-absorbing capital. It is absolutely critical to make sure that that is both freely available and appropriately priced to make sure you get the long-term finance for recovery.” Mr Skeoch called for measures to boost long-term confidence in financial markets and more risk taking by companies. These could include tax breaks for companies issuing equity to fund capital spending.

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He also sounded a warning over “contingent convertible,” or “coco” bonds, which have been used since the financial crisis as a funding source for banks but which risk losses if the bank’s financial health falls below a certain level. “What we don’t want is for something to go wrong, confidence to take a hit and have to reinvent this stuff,” he said. “I call them death-spiral bonds.” http://www.ft.com/intl/cms/s/0/81dfcf0c-f543-11e2-94e9- 00144feabdc0.html#axzz2ahabNsLX

ft.com GlobalEconomy EU Economy July 31, 2013 8:20 pm Cyprus economic reforms are on track but risks remain By Kerin Hope in Athens and Andreas Hadjipapas in Nicosia

©AFP Cyprus’s economic reform programme is on track, but substantial risks remain, according to EU and International Monetary Fund monitors. The island’s prospects are regarded as remaining uncertain as authorities struggle to contain a deepening recession and rebuild confidence in the battered banking system. More ON THIS STORY/ Cyprus leader calls for bailout overhaul/ In depth Cyprus bailout/ Asmussen calls for bank resolution fund/ Cypriot anger at slow reform/ Cyprus Storm in a Mediterranean tea cup? ON THIS TOPIC/Milder Cyprus bail-in terms unveiled / Former Cyprus defence minister guilty/ Cyprus seeks to ease bailout terms/ Cyprus to crack down on graft IN EU ECONOMY/ Portugal to ask leniency over austerity/ IMF warns of €11bn Greek bailout shortfall/ EU penalises Faroes in fishing dispute/ You say you want ECB minutes? We got minutes “While the authorities have started to implement the programme with determination, risks remain substantial. . . The short-term outlook remains difficult and subject to considerable uncertainty,” the troika of the European Commission, European Central Bank and IMF said in a statement on Wednesday after their first assessment mission since a €10bn international bailout in March.

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The troika’s positive report on reform effectively clears Cyprus to receive a €1.5bn tranche of aid in September from the EU and another €86m from the IMF. Yet the Cypriot economy is projected to shrink by about 13 per cent in 2013 and 2014, with the eurozone’s first capital movement controls, imposed in March as a bailout condition, constraining private sector activity. Controls have been gradually eased, but are likely to continue for another 24 months, according to local bankers. Cyprus has met fiscal targets set by international lenders, while Bank of Cyprus, the country’s largest bank, has been recapitalised with funds raised through a 47.5 per cent “haircut” of uninsured deposits. Co-operative credit institutions, which used to account for about a third of lending, will be restructured and recapitalised by the end of this year without imposing a haircut on depositors, the statement said. Underscoring a rapid weakening of the labour market, the jobless rate jumped to 17.3 per cent in April from 11.7 per cent a year earlier – the largest annual increase in the eurozone, according to official figures released on Wednesday. Despite the island’s economic problems, Greek and Turkish Cypriots are preparing to resume peace talks under UN auspices in October after a 14-month hiatus. Both sides have appointed negotiators to lead a fresh attempt to reunify the two communities in a loose federation. Cyprus has been divided since Turkish troops occupied its northern third in 1974 in response to an Athens-inspired coup aimed at union with Greece. http://www.ft.com/intl/cms/s/0/22a526a2-fa0e-11e2-98e0- 00144feabdc0.html#axzz2ahabNsLX

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Daily Morning Newsbriefing August 01, 2013 A Latin American rebellion in the IMF over Greece A Latin American rebellion inside the IMF against the Greek bailout programme and the latest IMF review suggesting a funding gap of €11bn for the coming two years puts enormous pressure on Europe. Paulo Nogueira Batista, who represents Brazil and 10 other member countries, said he doubted the IMF staff’s forecasts for Greece’s debt and economic growth, calling them a “delusion.” Batista suggested there was a real danger the IMF might not get its money back from Greece and that the country had been pushed to the edge through the consolidation programme. “The widespread perception that the hardship brought on by Draconian adjustment policies is not paying off in any way has further undermined public support for the adjustment and reform program.” Batista’s intervention is one of the toughest views expressed inside the IMF since the Greek bailout began three years ago. Although his abstention had no direct implications on the Greek aid programme, as the share is only 2.6% of IMF board votes, it will raise the pressure on IMF officials to take an increasingly tough stand with eurozone leaders, who are reluctant to accept losses on their existing bailout loans, writes Peter Spiegel in the FT. On the other front is the IMF’s latest review, which showed that Greece faces an €11bn funding gap, another €4.4bn next year and €6.5bn in 2015 and will need further debt relief, Kathimerini reports. In its 207-page report of the fourth review of the Greek adjustment programme, the IMF raised serious questions about the scheme’s sustainability. The report suggests that Greece would need a debt reduction equivalent to 4% of its GDP, or some €7.4bn, between 2014 and 2015 in order for its debt to become sustainable. The Fund urged the eurozone to confront the issue sooner rather than later. But the report was positive that Greece will start to grow again next year, the only uncertainty is timing. Though the report raised concerns about the public sector reform and the mobility scheme where it finds that the focus shifted away from dismissal to relocation. Another issue it takes with tax collection, with Poul Thomsen warning that without more progress, a credible 2014 budget would again need to be centered on painful expenditure cuts. A ballooning funding gap and uncertainty raised by Mr Batista about the IMF’s positive growth forecast is bad news in the worst possible moment. IMF rules mean it cannot continue to fund the Greek bailout unless it is convinced that the country is fully financed for the next 12 months. This means they need some assurances before their October vote. And German elections in September reportedly freezes any debate about further funds until then.

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Another coalition MP will not back Greek government legislation PASOK’s Theodora Tzakri becomes the latest coalition lawmaker to refuse to support legislation on Wednesday, Kathimerini reports. The bill was about the settling of state debt to the Athens Water and Sewage Company (EYDAP), a move that is seen as a step toward privatizing the service. The amendment passed with just 51 votes in favour and 44 against in Parliament’s pared-down summer session. After the ballot, Tzakri accused Prime Minister Antonis Samaras of wanting to sell the family silver. Tzakri is the fifth lawmaker from New Democracy and PASOK this month to fail to support government legislation. So far no MPs have been expelled as the two-party administration only has a five-seat parliamentary majority. Bundesbank opposes publication of minutes We wonder who the journalists at Frankfurter Allgemeine have been talking too. Their anonymous central bank sources were a lot more hostile about the proposed publication of minutes than Mario Draghi, Benoit Coeure and Jorg Asmussen. As a result, there won’t be a quick decision. FAZ cites unnamed central bankers as saying that Draghi was against the publication of voting records, and prefers anonymous minutes. There would also be opposition from the peripheral countries, where governors might come under public pressure to act in support of the country. The article contains the much repeated – and tired – argument that once you publish minutes, all the important discussions would take place during dinner, not in the official session. An alternative model, as suggested by the article, is the Fed model, where the voting record is published, but the debate is paraphrased. The anonymous “central bank sources” behind that story are not hard to make out. The Bundesbank has been rejecting central transparency for ever. The argument that this would end all useful discussion is complete nonsense, since we now have quite a bit of experience with transparency in other central banks, where none of this “we will then only talk over dinner” stuff ever happened. The implicit assumption behind that statement is that central bankers do not want to be held accountable for their views – which may be true of some, but not for everybody. We suspect the true reason is that the weaker members of the governing council do not want to be exposed. Recovery watch There is more statistical evidence that the recession is slowly coming to an end. Reuters reports that the number of registered unemployed in the eurozone has fallen by 24,000 in June– a number too low to make any dent in the overall unemployment rate of 12.1%, but it is the first trend change in two years. Italy’s produced a revealing set of data that might explain that miraculous drop in unemployment. Italy’s own unemployment rate fell from 12.2% to 12.1% in June, but inactivity rose by 40,000. As La Stampa reports, the June employment rate was at 55.8%, while the level of the last year was at 56,8%. While confidence data are pointing upwards, real data continue to be mixed. The French government is preparing to cut its growth forecast for 2014 from currently 1.2% to below 1%, Les Echos reports. The article quotes Pierre Moscovici saying on RTL that the forecasts are on the downside in France and Europe and that the government is preparing for a growth rate of below 1% next year. Other government sources are quoted as saying that the figure cannot be too far away from the consensus forecast (0.6%) and that of the international institutions (IMF:0.8%). The exact figure will be out end of August.

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Frankfurter Allgemeine Zeitung, in its monthly economic bulletin on the eurozone, notes that despite the improved confidence indicators, the outlook for the eurozone economy remains bleak. It quotes a senior economist of the Ifo institute as saying that the eurozone will not recover until Q4, during which growth will very weak. Without Germany, the rest of the eurozone will remain stuck in recession for the entire year. Capacity utilisation remains extremely weak and unemployment high. Spanish peak-to-trough house price decline put at 45% In his presentation of BBVA's accounts for the first half of 2013, CEO Ángel Cano included a projection that by the end of the year housing prices will have dropped by 35% from their peak, and possibly 45% by the end of 2013. writes El Economista. Meanwhile, Bloomberg has a story about the prospects that Spain's bad bank SAREB may decide to demolish at least part of its stock of unfinished new homes, which are very unlikely to be sold. Taking down the buildings would free the land for other uses. Italy to boost resources to repay private companies The Italian Senate approved the allocation of an additional €20 to €25bn to pay overdue bills owed by the public sector to private firms, as La Repubblica reports. The amount will be made available after January 1, 2014 and is in addition to the €40bn already allocated. The Bank of Italy reckons the Italian public administration owes about €90bn to private companies. In order to boost investments, eligible private businesses will be granted promissory notes guaranteed by the State and redeemable from a fund created by the Cassa dei Depositi e Prestiti, the State’s savings and finance body. According to the Labour Ministry, Italy has debts with over 65% of Italian private firms. According to La Repubblica, the first tranche of the payments could be released by September. Italy launches tax breaks to fight youth unemployment As Il Corriere della Sera reports, the Italian Senate finally approved the bill that gives companies a series of tax breaks to encourage them to take on young people and create 200,000 new jobs next year. The bill introduces tax cuts of up to €650/month per worker for a maximum period of 18 months for new hires and 12 months for employees whose temporary or freelance contracts become permanent. The decree also includes the postponement of a scheduled 1% rise in the top band of VAT until October. Lavoce dismisses the measures and says they won’t solve the State’s unemployment problems. Italy cannot repair its broken labor market through decrees and useless bills without investments, privatizations and a new justice system. In addition, private companies should be supported by the state though commercial deals with other countries, as happens in France, Lavoce reminds. Don’t trust the calm Peter Spiegel has a good analysis in the Financial Times, where he says that the current calm may be deceptive, as there are a number of latent political storms around the corner. In Greece the support for the two mainstream parties has fallen to below 40%. Italy’s governments hovers on the brink of collapse. There is political instability in Portugal, and crisis in Spain. And yet, investors have been shrugging this off. Spiegel says there can be no doubt that Portugal and Greece will both need new bailouts soon. The lack of turmoil can only mean one of two things: either investors have been lulled into a false sense of security or the eurozone crisis is over. Spiegel does not give a definitive answer. He says the mechanism of a crisis would have been a bank run – which did not happen, nor is likely to happen now. The main problem is Italy. if OMT

153 is ever used, it will require the approval of the Bundestag. And that the market could become nervous again, when they are reminded that OMT is not the same as discretionary QE. There are several ways through which the crisis can return, one of which described in this article. Another is a long-drawn out phase of zero or low growth, with little progress on employment. Another danger point will be the time when Germany will have to accept – or reject – OSI. Or if the constitutional court decides that OMT is unconstitutional. Or if Greece decides that it has had enough and that the costs of default and exit would be lower than not-default and stay. Where we agree with Spiegel is that the outcome is unforecastable. This is genuine uncertainty. The euro might succeed, or it might not. We just do not know. Bild turns against Merkel’s man There are two separate political scandals affecting two of Angela Merkel’s closest supporters – a recently surfaced plagiarism scandal involving Norbert Lammert, president of the Bundestag, and a military cost overrun scandal that may yet sink defence minister Thomas de Maiziere. As so often with scandals, the problem is not usually the original event, but the way politicians are handling the crisis. Bild, which normally supports Merkel, yesterday effectively called for the resignation of de Maiziere, effectively calling him a liar – because he appeared to suggest to the Bundestag several weeks ago that he had not been informed about the cost-overruns of the Euro-Hawk unmanned aircraft project. At his testimony then, he clearly gave the impression that he had not been informed, but later emphasised that his originally statement was sufficiently vague to allow another interpretation. An email was later discovered by a senior aide, which had explicitly warned about those cost overruns. Bild said this is not good enough for a minister, and concluded the article saying that the impression remains that he lied. The art of defaulting Hans-Joachim Voth and Mauricio Drelichman have a hilarious commentary in the Financial Times about King Philip II of Spain, who managed to amass 60% debt relative to the country’s GDP, while defaulting over and over again. They said there was much to learn from the defaults of sixteenth century Europe. The Genoese lenders to Philip II had create a highly efficient sovereign borrowing system, which survived even the Spanish Armada disaster in 1588. While Spain defaulted on several occasion, none of the lenders lost money in the long term, as they simply charged higher interest rates in normal time to compensate for the risk of default in crises. When these crises hit, debt contracts were quickly restructured, in as little as 12 to 18 months. Haircuts of typically 20 to 40% were imposed, and lending resumed promptly. They conclude that cycles of lending and default are not a sign of bankers’ stupidity, contrary to popular believe. They concluded that “the age of the galleon produced effective risk- sharing and a stable banking system; the age of the internet and jet travel is failing to do the same.” Schieritz on Steinbruck Mark Schieritz expresses outrage at an interview given by Peer Steinbruck to the Wall Street Journal, in which he suggested that an administration under his leadership would be more generous to thes crisis countries. Schieritz note that what appears to be a policy shift, is nothing of the sort as Steinbruck explains the sources of funding for his generosity, or the Marshall Plan B, as he calls it: it should be funded out of existing EU

154 funds, and from the proceeds of the financial transactions tax. Schieritz notes dryly the SPD plan is to funded by money that has already been spent and a tax that may never see the light of day as there is insufficient political consensus. He concluded that Steinbruck was trying to insult the intelligence of the voters. Munchau on the SPD In the first instalment of a four-part series on the election platforms of the main political parties in Germany, Wolfgang Munchau expressed disappointment about the SPD’s platform, and criticises the almost exclusive emphasis on financial sector reform to the exclusion of everything else. For once, the proposed reforms do not even address the main financial sector problem – that of undercapitalised banks. But what is really disturbing to Munchau is that this once Keynesian party has now fully bought in to the neo-classical policy consensus in Germany, and accepts further fiscal retrenchment without any discussion. The SPD thus offers no macroeconomic alternative policies at all. He says those who support Angela Merkel have no reason to fear Peer Steinbruck. But those who do not, have no reason have no reason to vote for him either. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.600 0.566 0.575 Italy 2.742 2.707 2.771 Spain 2.956 2.955 2.984 Portugal 4.789 4.772 4.894 Greece 8.467 8.457 8.47 Ireland 2.227 2.229 2.292 Belgium 0.885 0.856 0.864 Bund Yield 1.669 1.669 1.605

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.328 1.3249

Yen 129.690 130.7

Pound 0.873 0.8745

Swiss Franc 1.231 1.2319

ZC Inflation Swaps

previous last close

1 yr 1.45 1.42

2 yr 1.43 1.27

5 yr 1.58 1.57

10 yr 1.94 1.93

155

Euribor-OIS Spread

previous last close

1 Week -5.371 -5.771

1 Month -3.100 -3.6

3 Months 4.314 3.814

1 Year 32.243 30.943

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-08- 01.html?cHash=a0f7ddfb9d714abe515ab47474edf363

ROPE NEWS Updated July 31, 2013, 3:18 a.m. ET Merkel Rival Kicks Off Campaign, Hits Out at Austerity, Social Issues Peer Steinbrück on the Attack, as He Trails Angela Merkel by a Wide Margin in the Polls The left-of-center challenger in Germany’s September election, Peer Steinbruck, says in a WSJ interview that he would let up on Chancellor Merkel’s austerity policiesand would pursue a hard line with the U.S. over the NSA scandal. BERLIN— Angela Merkel's main challenger in German elections this fall lashed out at the chancellor's austerity policies for Southern Europe but said he wouldn't support further debt relief for Greece. "Her therapy is consolidation, consolidation, consolidation," Peer Steinbrück, of the left-of-center Social Democrats, said in an interview. "But this is not the way these countries can recover." Chancellor-hopeful Mr. Steinbrück, a 66-year-old former finance minister in Ms. Merkel's cabinet who is lagging behind her in the polls, called for a "Marshall Plan B" for Southern Europe, referring to the U.S. aid program for rebuilding Europe after World War II. He said that as chancellor, he would push harder for measures to stimulate economies from Greece to Spain and to subsidize businesses hiring young people in European countries with high youth unemployment. Social Democrat Party chancellor candidate Peer Steinbrueck presented the SPD's election campaign for the upcoming general elections in Berlin Tuesday. Interviewed at the Social Democrats' headquarters in Berlin, where a large image of Karl Marx hangs in the hallway, Mr. Steinbrück sharpened his criticism of Ms. Merkel's handling of the euro crisis. The general election is scheduled for Sept. 22 and policy makers around the world are watching for how Europe's biggest economy navigates the Continent's stubborn recession and financial woes.

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European Pressphoto Agency With Germany doing relatively well economically, the crisis in the countries to the south is hardly a campaign issue. But Mr. Steinbrück suggested he may be more generous than Ms. Merkel and praised the European Central Bank for assisting struggling states, even as creditor nations led by Germany focused largely on austerity. Paring down public-sector budget deficits is still necessary, Mr. Steinbrück said, but he suggested the process should happen at a more-measured pace than what Ms. Merkel's government has been pushing in Greece and elsewhere. Critics say that giving troubled countries more time to bring their fiscal house in order would slow the pace of much-needed overhauls, such as trimming bloated bureaucracies. And other proponents of austerity like Austria and Finland would likely oppose such a move. Mr. Steinbrück said money to fund additional stimulus for countries in financial crisis could come from existing European Union funding pools and from an oft-proposed tax on financial transactions. An EU proposal for a financial-transaction tax has become bogged down in debates over details. And while the EU already makes available a total of €49 billion ($65 billion) a year from the bloc's budget to support its poorer nations and regions, Greece and others have struggled to find fresh projects for which to tap the unused part of those funds. Mr. Steinbrück said he would oppose forgiving some of Athens's debt, even though Greece is struggling with a debt load that the International Monetary Fund calls exceptionally high. The problem, he said, is that debt forgiveness would lead to losses for European taxpayers and could dissuade private investors from lending money to Greece in the future. Germany and other countries now hold much of Greece's debt. In recent years, Ms. Merkel has been willing to put German taxpayer money on the line to bail out Greece and Cyprus, among others, and to keep Europe's currency zone intact. But she has advocated painful spending cuts costing thousands of jobs in Southern Europe and hampering economic recovery. "She leads her European policy very much with an eye on a voting public that says we don't want to be the paymaster of Europe," Mr. Steinbrück said of Ms. Merkel. "That's very popular. Whether it's really right to play this tune in the short term and medium term is, for me, a big question mark."

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Public-opinion surveys suggest Ms. Merkel is headed for a third term, with her right-of- center Christian Democratic Union polling better than the prospective leftist coalition of Mr. Steinbrück's Social Democrats and the environmentalist Greens. Mr. Steinbrück and his allies, however, say the situation could change in the final weeks of the campaign because polls have shown that many Germans don't make up their mind until days before they vote. Still, Ms. Merkel has received high marks from Germans for her handling of the euro crisis. Germany's unemployment rate of 5.3% is the country's lowest in two decades, and Ms. Merkel's approval ratings of more than 60% are among the highest for a German chancellor. The Social Democrats, the largest opposition party in parliament, have largely supported her Europe policies when they've come to a vote. Mr. Steinbrück said that the European Central Bank's low-rate policy and its bond- buying program known as Outright Monetary Transactions has played an important role in easing countries' pain. "The ECB has become a sort of substitute actor because the heads of state and heads of government haven't been willing or able to broaden their crisis management beyond simple fiscal consolidation—largely under German influence," Mr. Steinbrück said. "In that respect Mario Draghi with his announcement of the OMT program last fall provided a far-reaching impetus." Mr. Steinbrück said the ECB's bond buying was testing the central bank's mandate, but he declined to comment on whether the program exceeded the bank's bounds. One of Germany's top courts is set to decide on the constitutionality of the ECB program later this year. Ms. Merkel and her cabinet in recent weeks have tried to soften their image in southern Europe. Finance Minister Wolfgang Schäuble visited Greece in mid-July and offered €100 million for a fund to boost economic growth. A month ago, Ms. Merkel hosted a summit of EU leaders in Berlin to discuss how to spend 6 billion euros they'd set aside to fight youth unemployment—a sum that Mr. Steinbrück called laughably small. The euro crisis is largely overshadowed by domestic issues on Germany's campaign trail. Mr. Steinbrück presented the Social Democrats' election agenda in a traditionally working class neighborhood of Berlin on Tuesday and focused on social issues such as wages, child care, and rent. He has seized on press reports based on disclosures by former intelligence contractor Edward Snowden that the U.S. National Security Agency has been engaged in widespread snooping on German communications. Ms. Merkel, he alleges, hasn't been firm enough with the U.S. government in protecting citizens' interests. "We're talking about a scale that is infringing on fundamental rights in Germany," Mr. Steinbrück said. "I'm expecting every chancellor of the German Federal Republic to go to Washington and to ask what exactly is happening here in Germany and are my people subject of these surveillance activities of the NSA?"// Harriet Torry contributed to this article. //A version of this article appeared July 31, 2013, on page A14 in the U.S. edition of The Wall Street Journal, with the headline: German Rival Slams Merkel Over Austerity.// http://online.wsj.com/article/SB10001424127887323854904578637632935746970.html #printMode

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Empresas y finanzas Jueves, 1 de Agosto de 2013 El precio de la vivienda caerá otro 10% en 2014, según BBVA Europa Press / Servimedia 31/07/2013 - 14:13 El consejero delegado de BBVA, Ángel Cano, ha estimado que la caída real de precios se situará en el entorno del 35% al cierre de este ejercicio y que podría llegar hasta el 45% entre este año y 2014, lo que supondría un recorte adicional del 10%. Además, ha comunicado que la entidad se ha desprendido de más de 8.600 inmuebles hasta junio. Enlaces relacionados: BBVA gana 2.882 millones hasta junio, el 10% más. Por tanto, Cano considera que desde ahora y hasta final del próximo año 2014 "podríamos ver una caída adicional" de los precios. Según explicó el directivo de la entidad financiera, el descenso de los precios inmobiliarios son muy "heterogéneos" dependiendo de las comunidades autónomas y las zonas geográficas. En la presentación de resultados correspondientes al primer semestre del año, Cano ha defendido el ritmo de venta de activos inmobiliarios "de menos a más" emprendido por el 'banco azul', al tiempo que ha puesto en valor la tasa de cobertura del 44% en su exposición a este sector tras las provisiones exigidas. En los seis primeros meses, BBVA logró vender en el primer semestre del ejercicio más de 8.600 inmuebles. De esta cifra, unos 6.600 activos inmobiliarios han sido comercializados directamente por la entidad. El resto, unas 2.000 unidades, corresponden a promociones que la entidad tenía en libros pero que eran propiedad de clientes promotores del banco. El consejero delegado ha asegurado que la entidad sigue reduciendo el riesgo inmobiliario y ha añadido que las provisiones están "bastantes ajustadas", habida cuenta de que a junio de este año la ventas se han realizado prácticamente al valor contable en libros. Interesado en las nacionalizadas Sobre la venta de las entidades nacionalizadas, Cano a explicado que BBVA va a analizar "y va a ver todos los papeles y el libro de información" de CatalunyaBanc y NCG. Según ha recordado, el banco analizará la compra de estas dos entidades buscando la generación de valor para el accionista, al mismo tiempo que ha descartado que el banco tenga a la venta ningún activo estratégico. En este sentido, el consejero delegado del BBVA ha hecho referencia al banco turco Garanti, sobre el que ha valorado su "excelente" evolución de los últimos trimestres y su "perfecta" integración en el grupo. http://www.eleconomista.es/empresas-finanzas/noticias/5036288/07/13/El-precio-de- la-vivienda-caera-otro-10-en-2014-segun-BBVA.html

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ft.com World Europe Last updated: July 31, 2013 2:54 pm Latin American countries rail against IMF over Greek bailout By Peter Spiegel in Brussels

©Bloomberg Brazil’s representative to the International Monetary Fund’s executive board abstained from approving the fund’s new €1.8bn contribution to Greece this week and issued a stinging criticism, arguing that Athens might be unable to repay its rescue loans. Paulo Nogueira Batista, who represents 11 Central and South American countries on the IMF board, said Greece’s political and economic difficulties “confirm some of our worst fears”, adding the fund’s own economists were making “over-optimistic” assumptions about economic growth and the sustainability of its debt. More ON THIS STORY/ IMF warns of €11bn Greek bailout shortfall/ In depth Greek debt crisis/ Global Insight Eurozone calm masks brewing political storm/ beyondbrics A brief history of Brazilian bolshiness/ Greece secures €4.8bn bailout tranche ON THIS TOPIC/ The Macro Sweep UK, US, Turkey/ Markets Insight Cross-border equity ownership is key to eurozone risk-sharing/ Martin Sandbu Europe should let go of hopeless causes/ Global Insight Paralysis may extend past German election IN EUROPE/ Italy awaits Berlusconi appeal verdict/ Lacklustre GDP data push Ukraine towards fresh IMF bailout/ Bayern chairman charged over tax evasion/ Milder Cyprus bail-in terms unveiled “Never-ending economic depression and severe unemployment levels have led to political discord,” wrote Mr Batista. “The widespread perception that the hardship brought on by draconian adjustment policies is not paying off in any way has further undermined public support for the adjustment and reform programme.” Developing countries have long been uncomfortable about the outsized fund resources being devoted to the eurozone crisis, with Brazil voicing concern that an organisation aimed at helping poorer countries is being used to shore up some of the world’s largest economies. But Mr Batista’s abstention and harsh statement – which included his assessment that the IMF’s Greece staff was “one step short of openly contemplating the possibility of a default or payment delays by Greece on its liabilities to the IMF” – is one of the toughest stands taken since the Greek bailout began three years ago.

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It came as the IMF itself issued a report calling on eurozone countries to provide €11bn more funding for the Greek bailout and consider big writedowns of their bailout loans to Athens in order to reduce debt to more reasonable levels. “This abstention undermines the belief that IMF disagreement between the Europeans and emerging markets over Greece are a thing of the past,” said Mujtaba Rahman, head Europe analyst at the Eurasia Group risk consultancy. “Ahead of difficult negotiations on a third bailout and debt writedowns this fall, this signal of disarray from within the IMF could not have come at a worse time.” The warnings come amid a national election campaign in Germany where tolerance for more Greek aid and debt relief is waning and opposition parties have attempted to make Chancellor Angela Merkel’s handling of the bailout a campaign issue. German officials pointed to recent findings by international monitors, which include the IMF, that the bailout was hitting its fiscal targets, arguing that it was therefore not appropriate to discuss new Greek assistance. In depth Greece debt crisis Greece struggles on with drastic austerity as eurozone leaders continue to argue over how to help the country cope with its debt mountain In an interview, Mr Batista said that while he had abstained in the past, he was now convinced that Greece’s second €172bn bailout suffered from the same rosy assumptions that hobbled the first rescue, which was later harshly criticised by the IMF itself. “The second programme suffers from many of the same problems as the first,” he said. Mr Batista’s abstention will have no direct impact on Greece’s aid; the Brazil-led group represents only 2.6 per cent of IMF board votes, which are dominated by European and US members. The board approved the payment on Monday, just two days before an end-of-month deadline. But it will raise the pressure on IMF officials to take an increasingly tough stand with eurozone leaders, who are reluctant to accept losses on their existing bailout loans. Brazil’s belligerence has grown since 2009 when, after decades of relying on the IMF to bail it out of a series of financial crises, it became a net creditor of the fund when it provided $10bn in financing to help developed countries hit by the financial crisis. Since then, Guido Mantega, Brazil’s finance minister, has emerged as one of the most outspoken critics of the IMF, calling for greater representation of developing countries on the board. Brazil’s new confidence as a global economic power has also led the country to put increasing pressure on the IMF on issues ranging from the acceptance of capital controls in global markets to even its methodology for calculating debt. Last week, it emerged that Brazil had asked the IMF to change the way it measures nations’ gross debt, which it said unfairly inflated its own liabilities. Additional reporting by Joseph Leahy and Samantha Pearson in São Paulo and Quentin Peel in Berlin http://www.ft.com/intl/cms/s/0/41aebbb4-f9cb-11e2-b8ef- 00144feabdc0.html#axzz2ahabNsLX

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ft.com World Europe GLOBAL INSIGHT July 31, 2013 1:14 pm Eurozone calm belies brewing political storm By Peter Spiegel in Brussels Investors appear to have shrugged off peripheral nation turmoil Take a quick political stability tour of the eurozone’s southern periphery and it would be hard to argue things have ever been worse since the outset of Europe’s sovereign debt crisis. Greece’s two mainstream parties are now barely clinging to their governing majority, with extremist parties on the left and right polling a combined 40 per cent. Italy’s technocratic government has spent its entire short existence firefighting and seems perpetually on the brink of collapse. More ON THIS TOPIC/ Brazil hits out at IMF over Greek bailout/ The Macro Sweep UK, US, Turkey/ Markets Insight Cross-border equity ownership is key to eurozone risk-sharing/ Martin Sandbu Europe should let go of hopeless causes GLOBAL INSIGHT/ Islamists not blame-free in Morsi’s fall/ Paralysis may extend past German election/ ‘People’s Pope’ connects with Brazil poor/ Insults and division as India’s election phoney war gathers pace Spain is in the midst of a payola scandal allegedly so vast that it would fell any government in a system without Madrid’s iron-fisted party discipline. And Portugal’s prime minister is only able to fend off snap elections by giving authority to deal with bailout lenders to the head of his anti-austerity junior coalition partner. It is a pretty grim survey. And yet, other than a brief wobble at the height of the recent Greek and Portuguese dramas, investors seem to have shrugged it off entirely. To be sure, both Portugal and Greece are likely to need new bailouts soon since neither is expected to be able to raise enough cash on their own when current rescue loans run out in the middle of next year. But the lack of wider market turmoil amid the current political wreckage can only mean one of two things: either investors have been lulled into a false sense of security or the eurozone crisis as we once knew it is over. So is it possible the hair-on-fire first act of the eurozone saga has ended? Ever since its start, the existential threat to the single currency has mainly come from two separate but related scenarios: a massive bank run by depositors convinced their euros were about to be turned back into drachmas, escudos or pesetas; or Italy losing access to the bond market, making it unable to refinance its massive €2tn debt pile. Under either scenario, bailouts needed would be so big that there simply would not be enough cash available, forcing massive defaults and a euro break-up. The idea of a bank run now seems improbable since depositors have shown remarkable resilience despite almost constant provocation. 162

In depth Euro in crisis //As the debt storm spreads Europe’s leaders battle to save the eurozone Just 18 months ago, after then Greek prime minister George Papandreou threatened to put his country’s bailout to a national referendum, EU leaders publicly declared euro membership voluntary by insisting any Greek referendum be an “in or out” vote. In March, they went even further to spook depositors by forcing Cypriot bank account holders to pay for their country’s €10bn bailout. But neither event, which some predicted would spur lines outside wobbly Spanish banks, caused more than a relatively mild “bank jog”. EU leaders even recently codified the principle that bank bailouts should be paid for by private cash – including, in extremis, bank deposits – despite the continuing questionable health of Europe’s financial system. If none of that has led to bank runs, nothing will. Which leaves Italy. Despite all that has been done in Brussels – a new €500bn bailout fund, tough debt and deficit rules, a nascent “banking union” – none of it will really save Italy if the markets decide Rome’s debt is unsustainable. The only thing that would remain between Italy and the abyss is the printing presses of the European Central Bank, which Mario Draghi a year ago vowed to deploy. That is a formidable firewall, and Mr Draghi’s bond-buying programme, known as Outright Monetary Transactions, has soothed the markets like nothing else has. But OMT is as much a political tool as a monetary one and can only be deployed if a troubled country submits itself to a Brussels-approved rescue programme first – a programme that must pass muster, among other places, in the German Bundestag. Which is why the new political turmoil in the south matters. OMT has never been tested. If one of those governments were to fall and be replaced by anti-bailout populists, the markets will very quickly be reminded that ECB bond buying is not the same as Bank of England or US Federal Reserve bond buying. It is at the discretion of political opinion in already put-upon parliamentarians in Germany and other creditor countries. So the current calm could mark the end of the beginning. Or it could be a lull before the storm. http://www.ft.com/intl/cms/s/0/bf8f52a4-f9d1-11e2-b8ef- 00144feabdc0.html#ixzz2aedWL9Rs

ft.com Comment Opinion

July 31, 2013 6:46 pm Banks should learn from Habsburg Spain By Hans-Joachim Voth and Mauricio Drelichman Risk transfers worked in the 16th century, write Hans-Joachim Voth and Mauricio Drelichman

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©Bloomberg Investors in the volatile debt of Ireland, Portugal, Spain and Italy can be forgiven a sense of déjà vu. The history of sovereign debt is strewn with promises broken, creditors losing their shirts (and sometimes literally their heads) and, during defaults, economic malaise. So does the long, melancholy history of government borrowing offer any lessons for policy makers today? Carmen Reinhart and Kenneth Rogoff, in their classic study of eight centuries of financial crises, argue that the repeated folly of investors is the cause of sovereign debt problems. After a few good years, creditors forget the risks, lend recklessly, then end up snared in a default. The cycle soon restarts as new investors convince themselves “this time is different”. More ON THIS STORY/ Brazil hits out at IMF over Greek bailout/ Global Insight Eurozone calm masks brewing political storm/ Greece secures €4.8bn bailout tranche/ Schäuble on ‘confidence’ trip to Greece/ Samuel Brittan The spell of magic numbers IN OPINION/ John McDermott Happy birthday, minimum wage/ Robert Jenkins Don’t buy the Barclays hype/ Hurdles next Fed chair must clear/ Ben Judah Israelis need to drop the dreaming At the dawn of sovereign lending, King Philip II of Spain – ruler between 1556 and 1598 of the only superpower of his age – signed hundreds of loan contracts. He also became the first serial defaulter, halting payments four times. The story of a powerful monarch able to convince creditors to lend as much as 60 per cent of gross domestic product while defaulting again and again offers useful insights into how the bargain can be improved. Sovereign debt crises today “hurt” in three ways. First, when bond markets panic and yields rise in a downturn, taxes are raised and spending is cut. Austerity aggravates the slump. Second, a country’s banking system typically implodes. Third, the return to debt markets is often long delayed; state employees are sacked, contractors go unpaid, and the economic slump deepens. By contrast, Genoese lenders to Philip II created a safe and stable sovereign borrowing system. It survived shocks such as the failed 1588 invasion of England with the Armada. Most bankers lent to the king for decades; no lender lost money in the long term. Financiers simply charged higher rates in normal times to compensate for the risks during crises. When shocks hit – such as a combination of low silver revenues and a costly war against the Ottomans – debt contracts were not expected to be honoured to the letter. Renegotiations were concluded fast – in 12 to 18 months, compared with today’s average of six to seven years. “Haircuts” for investors, from 20 to 40 per cent, were moderate. Lending resumed promptly.

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Even in normal times, lenders and borrowers shared risk effectively. A large fraction of Philip II’s short-term debt was “state contingent” – repayment terms and interest rates were automatically adjusted in line with fiscal conditions. In bad times – when the silver fleet from the Americas was small, say – the king either repaid less or extended the maturity of a loan. This avoided the need to let soldiers go unpaid. Automatic loan modification enabled Spain to avoid negative feedback loops such as those seen in southern Europe today, with falling tax revenue leading to austerity and hence an even more severe slump. The ability to write state-contingent debt using an easily observed indicator of fiscal health, such as the arrival of a fleet, was crucial. In modern debt markets, verifiable indicators such as value added tax receipts, certified economic growth figures or world oil prices could be used as measures of fiscal strength. The practices of the bankers, too, offer lessons for today. Loans were expensive and profits high. The Genoese absorbed losses easily because of their low leverage. Instead of borrowing themselves or taking deposits (as earlier competitors had done), they mostly financed themselves with equity. In addition, they sold the lion’s share of each loan on to other investors. Profits and losses were then distributed proportionately. During crises, everyone suffered, but no toxic concentration of risk threatened the bankers’ survival. In other words, risk transfers that failed during the recent subprime crisis worked well in the 16th century. Repeated cycles of lending and default, contrary to common belief, are not a sign of bankers’ stupidity. Often, creditors have realised that “next time will be the same”, and prepared themselves accordingly. They have provided effective insurance to the sovereign, and absorbed losses with thick equity cushions. The age of the galleon produced effective risk-sharing and a stable banking system; the age of the internet and jet travel is failing to do the same. The writers, who teach economic history in Barcelona and Vancouver, are the authors of the forthcoming ‘Lending to the Borrower from Hell’ http://www.ft.com/intl/cms/s/0/ff37ffda-f9dd-11e2-b8ef- 00144feabdc0.html#ixzz2aeejbG9z

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Daily Morning Newsbriefing

July 31, 2013 What to make of the good-news indicators? The last few days saw a series of positive economic indicators, combined with a re- evaluation of the economic prospects of the eurozone by several analysts. There was more yesterday. Reuters reports that the European Commission’s economic sentiment index rose from 91.3 points in June to 92.5 points in July. The euro zone's business climate index went up from from -0.67 in June to -0.53 points in July. Both present a 15-month peak. The data confirm that the recession of the eurozone is slowly ending, and making way for a return of moderate growth. Confidence improved across all areas except construction. The only country where sentiment continued to decline was the Netherlands. Portugal's business confidence improved for the seventh month in a row in July despite the political turmoil, Reuters reports. The economic climate indicator, which measures business confidence, stood at minus 2.6 this month, up from minus 2.9 in June, and also better than minus 3.8 a year earlier, the National Statistics Institute (INE) said. Its consumer confidence indicator also rose to a negative reading of 52.7 this month from minus 53.9 in June. The indices started to rebound from record lows in January, when Lisbon returned to the bond market for the first time since its 2011 bailout, and were further helped by the first benchmark 10-year bond issue in May. In Spain, the Spain's National Statistics Institute INE reported an estimate of a Q2 drop in GDP of 0.1% and annual drop of 1.7%. The numbers broadly agree with a recent estimate by the Bank of Spain. It will have been the eighth consecutive quarter of negative growth. INE also estimated Spain’s July HICP inflation at 1.9%, a slight fall from June. German annual HICP inflation rose to 1.9% in July, according to preliminary data from Germany’s Federal Statistics Office. The level is considered to be a cyclical peak by several analysts, as Reuters reports, who see inflation rates to fall back towards 1%. FT Alphaville presents a useful collection of some of the more optimistic economic research notes from banks and independent analysts. Two of those struck us as particularly noteworthy. Goldman Sachs noted that based on an analysis of trade in terms of ‘value added’ the economic restructuring in the periphery does not require nearly as much of a structural shift out of services into manufacturing as previously thought. This is because services are more tradable than commonly believed in value added terms. Goldman Sachs also believes that the slowdown in China is having less effect on eurozone exports than widely believed.

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There is also a reference in the longish Alphaville piece to a comment in Open Europe which cautioned against reading too much into the increases in PMI. It noted that absolutely levels are low, and many countries were still contracting, including France. This is a problem since the eurozone crisis is predominantly a crisis of divergence. It also noted that these surveys only relate to private sector consumption. Other components of GDP, including public spending and investment, continue to fall. We also believe that the data of the last few days underline that the eurozone’s recession is slowly ending, and that it may revert to positive growth rates in the second half of this year. They do not, as yet, give us any indication of the strength of the recovery, which we expect to be weak. The main reason for the continued weakness are the persistence of a weak banking system, and economic rebalancing, which could take many years to complete. Note that Spanish and German inflation rates have been converging but are likely to diverge again, with German rates expect to fall much more quickly. With German inflation falling to 1%, we cannot see how internal rebalancing can happen. We also agree with the point made by Open Europe that these indicators are still weak overall, and that other components of GDP – government spending and investment – continued to point downwards. The indicators tell us what we already know – or have been expecting, which is that the recession is slowly coming to an end.

Italy awaits the verdict The Italian Supreme Court has begun proceedings whether to uphold a tax-fraud conviction against Silvio Berlusconi. As Il Corriere della Sera reports, the Court could decide on a prison term and a five-year ban from holding public office. The verdict is expected today or tomorrow. Prosecutor Antonello Mura told the Court that Mediaset had persistently inflated costs for tax benefits and transferred assets abroad. Meanwhile, several PdL lawmakers have threatened that the party will pull its support and sink the government unless the sentence is overturned. They are saying that Berlusconi is the victim of persecution by left-wing magistrates, who are targeting him for political reasons. According to pundits like Il Sole 24 Ore’s Stefano Folli, Berlusconi’s legal problems and the government are separate issues, but the trial could nevertheless create a new uncertainty over Italy’s commitments to reform. However, according to La Stampa, the PD could cause the government to collapse too if the conviction is confirmed. As several party’s MPs confirms, the PD cannot accept to govern with an alliance partner led by a man with a definitive criminal conviction.

Italian banks need capital increase Italian mid-sized banks may have to raise new equity in the short and medium term, according to Fitch, as reported by Reuters. The non-performing loans ratio has been increasing throughout the crisis, and those banks needs to improve credit risk systems. In addition, they need to adopt internal rating models and a new deleveraging model to strengthen their balance sheets, Fitch said. Those banks likely to be subject to ECB supervision are projected to see the amount of impaired loans to worsen further throughout 2013 and 2014. Right now, only two banks, Banca Popolare di Milano and Banca Popolare di Vicenza, have announced and approved new share issues to take place in the second half of 2013, for at least €5bn in total.

Renzi’s plan Matteo Renzi and his aides are preparing a plan to boost the Italian economy through privatizations and structural reforms, the online news magazine Formiche reports. A

167 paper by Yoram Gutgeld, a former McKinsey economist and now PD MP, argues that Italy could exit from a position of high debt and low growth by selling off state real- estate and state shareholdings in ENI and Enel, the major energy utilities. With these measures, the government could lower corporate taxes and have the necessary financial leverage to introduce the long-run planned fiscal reforms, which is one of the biggest project of Silvio Berlusconi’s PdL. These proposals are likely to have a significant impact on the PD primaries. In fact, several MPs accused Renzi to be too close to the centre-right and to care too little about traditional Socialist issues such as workers’ rights. Last months, both Gutgeld and Renzi noted that Italy needed to implement structural reforms to revive missing growth and competitiveness, and do so without dogmatism.

Milder than expected final terms for Cyprus bail-in The Cyprus government and central bank on Tuesday announced milder than expected final terms of a bail-in for uninsured depositors but signalled it could take years before their remaining funds are fully unfrozen, the FT reports. Deposits above the guaranteed limit of €100000 will face a 47.5% haircut, while an additional 5% of total deposits would be made available for withdrawal by account holders on top of the 10% already returned in cash, according to a joint statement by the finance bank and the central bank. Depositors will receive shares in a slimmed down Bank of Cyprus as part of the bail-in and will earn interest on funds still frozen, which will be placed in six-, nine and 12- month time deposits with the bank retaining the right to roll them over. Christopher Pissarides, the Nobel Prize-winning Cypriot economist who is advising the government, said it could take up to two years before the eurozone’s first controls on capital movement, which were imposed in March, are fully lifted. The bail-in would wipe out about €8bn of deposits while still leaving Bank of Cyprus as the island’s largest lender. Former depositors in Popular Bank would hold about 18% of Bank of Cyprus, followed by Russian and Ukrainian companies represented by prominent Cypriot lawyers with about 16%, according to unofficial estimates.

Greek bank rescue fund has spent €38bn so far Greece's bank bailout fund HFSF has spent €38bn propping up the country's ailing bank system, three-quarters of the total endowment. About €25bn were used to bolster the capital of Greece's four biggest banks, an HFSF report said. It spent another €13bn to wind down eight small lenders as part of measures to shrink the country's banking sector. The rescue of Greece's banking system has been largely completed now. But lenders might need yet more capital to cope with bad loans. About a quarter of their loans are non-performing and that share might increase as the country's six-year recession, which has wiped out a quarter of the economy, shows little sign of abating. Stress tests will be carried out later this year to establish whether Greek banks have more capital needs.

Passos Coelho wins confidence vote Portugal's PM won the confidence vote with his new reshuffled government, Reuters reports. All MPs from the two parties of the centre-right ruling coalition, who have a solid majority in the house, voted in support of the motion of confidence.

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Speaking to parliament before the symbolic vote, Passos Coelho also said the economy was giving signs of nearing a turnaround. He vows to meet the bailout goals and says the corporate tax reform will have to be implemented gradually as there is no budgetary margin. Interestingly, the confidence vote is hardly mentioned in the Portuguese press this morning. Diario Economico reports that the Portuguese government wants to get all state reform acts approved before the troika returns early September, after they had been put on hol

French government in search of increasing tax revenues The French government studies whether to reintroduce a freeze of the income tax brackets to help reducing to deficit, Les Echos reports. The income tax itself would not increase but because the taxpayers’ income tends to rise at least with inflation, freezing the brackets means that income would end up in a higher tax progression. Sarkozy’s government got €1.7bn more tax revenues this way in 2012. If the tax is to be reintroduced in 2014, it will be targeted to the upper end of the scale, affecting 3m of the richer tax payers. Such a measure is expected to increase revenues of less than €1bn, although this also depends on the expected inflation rate. Other tax increases are under discussion as well. The government needs to raise €10bn- €12bn in extra tax revenues. Apart from those tax increases already announced, including the famous 75% on rich income, there are other avenues under consideration: rise of social charges to finance pensions, a new carbon tax is back on the agenda, anti- tax optimisation measures for companies and a renewed debate about whether or not the sectors currently enjoying a VAT rate of 5% can be moved up to 10%.

Now Draghi wants to publish minutes When we heard the proposal by Benoit Coeure and Jorg Asmussen about the publication of minutes, we suspected that this was not an isolated initiative. Mario Draghi has now come out in favour of the proposal himself, as Reuters reports, calling it a “necessary next step”. He said the board will presents a corresponding proposal to the governing council.

Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.614 0.600 0.597 Italy 2.802 2.729 2.731 Spain 2.980 2.956 2.964 Portugal 4.807 4.789 4.719 Greece 8.460 8.467 8.43 Ireland 2.233 2.227 2.218 Belgium 0.889 0.885 0.894 Bund Yield 1.665 1.669 1.667

Euro Bilateral Exchange Rate

Previous This morning

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Dollar 1.327 1.3255

Yen 130.260 129.65

Pound 0.865 0.8704

Swiss Franc 1.235 1.2322

ZC Inflation Swaps

previous last close

1 yr 1.39 1.48

2 yr 1.34 1.43

5 yr 1.47 1.58

10 yr 1.8 1.8

Euribor-OIS Spread

previous last close

1 Week -5.071 -4.671

1 Month -3.500 -2.7

3 Months 4.214 2.314

1 Year 29.414 31.514

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-07- 31.html?cHash=e72731cd7bfcb025531b0dcf6502ab51

170 naked capitalism

James Galbraith on Social Breakdown and Financial Stress in Europe and Why the Word “Stimulus” Needs to be Banned http://www.nakedcapitalism.com/2013/07/james-galbraith-on- social-breakdown-and-financial-stress-in-europe-and-why-the-word-stimulus-needs-to-be- banned.html Tuesday, July 30, 2013 James Galbraith on Social Breakdown and Financial Stress in Europe and Why the Word “Stimulus” Needs to be Banned Cross posted from Yanis Varoufakis‘ blog What follows is the extended, English language, version of James Galbraith’s recent interview by Roger Strassburg for NachDenkSeiten. Enjoy: RS: I was listening to your speeches. One of them that I found was kind of interesting was the one in Croatia, where you talked about true and false Keynesianism. What does that actually mean? JG: Well, it’s a politer term for the subspecies that John Robinson referred to by a somewhat ruder word. What I’m getting at there, hoping to stick some needles under the skin of certain people, is the misleading, and I think fundamentally anti-Keynesian idea that the macroeconomic task consists of stimulating, and thereby returning the economy from its present state to the track of potential output, which was previously considered to be normal. What’s wrong with this, is two things. First of all, it conveys the false impression that the macro-economic problem is a short-term problem amenable to a relatively short-term solution consisting largely just of increased spending or reduction of taxes. That, in turn diverts attention away from the problems that I think are effective barriers to such a return. So my view is that the Keynes, were he around today, would have a vivid appreciation of the difficulties and would be taking a strategic and long-term approach to these issues, putting in place institutional changes that in my view are required. They include, first of all, regulation of the debt issue, a transformation and restructuring of the banking sector, new institutions to provide employment to those who need it, and a strengthened system of comprehensive social insurance. All of those things were part of the New Deal formula, and they are all, I think, palpably essential, not to restore growth and full employment, but to face the much more urgent task of preventing any imminent disaster. RS: So you don’t necessarily think that the growth trend is a good measure? JG: I think any program which is predicated on reaching the previous trend growth in any short or medium term – or for that matter, reaching it at all – is doomed to disappointment, and it’s not a good idea to hold out a false benchmark as the predicate of an economic program. RS: At the same time, that was a trend that showed us at more or less full capacity. JG: I don’t know what full capacity means… RS: Everybody’s employed, more or less… JG: Ah, well that’s a different story. Full capacity is normally defined by the output potential of your capital equipment. There are two things that happen to capital equipment in major crashes. One is that it disappears, and the other is that when it is replaced, it is replaced – particularly in the present environment – by alternatives which are vastly labor saving. The consequence of

171 that is that – you already see this in the data – even the miserable growth rates that we have seen have not corresponded to a recovery of employment, even to the extent that you would have predicted from previous formulas. And I think that’s substantially due to two things: the destruction of the previous capital equipment and labor-saving technological change going forward. RS: There’s the school of thought that claims that labor is becoming obsolete, which is kind of an extreme way of putting it, but do you think that the work is running out? JG: Well, lets separate this into manageable pieces. Manufacturing employment in the U.S. Is already down to about eight percent of the labor force. That eight percent, most of that is not going away, it represents the people who are working in sectors where the U.S. remains a competitive player. The parts that are vulnerable, light industrial pieces, some of that will stay, notwithstanding what happens elsewhere in the world, and the amount that is still vulnerable to leaving is not a very large faction of total employment. And even if you lost it all, it would only be of the same order of magnitude of job losses that have already occurred in the crisis – we’ve lost eight million jobs, if we lost eleven million more, it’s not that much more. So that’s point number one. Point number two is the rest of the economy, which is another 130, 140 million people. It’s a much larger piece, and a lot of that is office work, a lot of that is information processing work, a lot of that is in various sectors of this kind where businesses have purged their labor forces, and as they continue to cope with a slow growth environment, they’re not keen to hire anybody back, so they’re substituting cheap technologies for expensive labor in every possible way. RS: Well, do you think that the economy will tend to develop new and different kinds of jobs? JG: I don’t think economies tend to develop those jobs. I think you have to create them. RS: Are they createable? JG: Of course they’re createable, sure. RS: So you wouldn’t go along with the notion that labor’s becoming obsolete? JG: No. Old people need care, and that’s what you hire young people to do, and this is perfectly manageable so long as somebody writes the checks. It’s not difficult. I don’t think it can be done effectively on a profit-making basis in every sector, but it can be done for sure. It’s actually not complicated to do. You just have to have institutions that do it and that provide the appropriate levels of quality control and that sort of thing. RS: In an environment where everyone’s trying to save money, of course, that’s not likely to happen. JG: Well, if you’re of the view that money is a physical constraint in the system, then you’re doomed. You’re not going to get there. RS: I know – you have to go dig it up out of the ground or something… JG: Right, exactly. RS: What about growth in general. You talked about growth not necessarily being able to follow the trends in the past. What do you see as limits on growth? There’s the Club of Rome position that things have to start shrinking, actually, because we’re growing too much. JG: My view is there are three or four major obstacles. One of them is resource costs, not the physical availability, but the cost of obtaining and also – if it were properly accounted for because of climate change – the cost of using the energy that we have. And it’s obvious that this has changed dramatically from forty years ago. Part of that is also the financialization of energy and commodity markets, which allows the economic rents to be extracted very rapidly if there is a movement toward faster growth. Energy prices go up very quickly, and then you get basically a tax on the system and a drain on demand as a result. That’s

172 again part of the problem of having a financialized global commodities market. So that’s point number one. Point number two – actually a subordinate point, but closely related – is that for a while in the 1990′s the United States believed that it could stabilize the world economy with military force. It’s obvious this doesn’t work, and the impact of that realization is being felt everywhere. Point number three is the effect of technology on labor demand going forward, it strikes me as a significant barrier to returning to full employment primarily on the strength of the private profit- making sector. And point number four is the collapse of the financial system, which is universal in Europe and the United States. The banking sectors are vast institutions that have served very little public purpose, if any. At this point, they could be run as public utilities, and the fixed cost that they presently impose on the economy could be lifted, and you would then have some more scope for private profitability in everything else, which would be a good thing. Now, does that mean that you could manage a world economy if you can’t get any growth at all, and go down into a constant negative growth rate? I do not understand how that works. Businesses are in the business of making money, and if they cannot make money, they will not operate at all. So I think that this would be a much more dramatic situation than the people who advocate it casually think. RS: You were talking about a “third way” when you were in Croatia. Could you elaborate on that a bit more as to what that would involve? JG: A “third way” between the Austerians and the Stimulards? It’s not a third way between those two alternatives. If I used the term “third way”, it was only in deference to the historical use of that phrase in Yugoslavia and Czechoslovakia. RS: You weren’t against stimulus, though, were you? JG: I am against the use of that word as a description of any viable economic strategy. Absolutely, I’m against the use of the word “stimulus”. I think it should be purged from the vocabulary of anybody advocating an effective alternative to austerity, because it is not an effective alternative to austerity. RS: And the alternative would be? JG: The first necessity is to stabilize the patient, who is on the verge of collapse. This is not about stimulus, it’s not about returning to growth, or returning to full employment, this is about preventing a disaster which will lead to the breakup of the Euro Zone and the European Union, and will lead in that direction in my view quite soon if nothing is done. So that’s what I’ve been talking about over the last month. My thoughts on this were very much crystallized by the visit to Greece after the trip to Croatia. The question is, what’s the evidence? Okay, here’s some evidence. The Greek government failed to sell its gas monopoly to Gazprom for a very modest sum because Gazprom’s analysts believe, accurately, that they could not trust the forecast of income from the gas monopoly. And did I mention that this is a gas monopoly? We are talking here about a reasonable projection on the part of a competent firm that the economy underpinning the revenue stream of the gas monopoly is failing. Right? It doesn’t take much if we ask ourselves, on what basis does a rational government sell a gas monopoly for cash? The only reasonable answer is: When it needs cash immediately and does not expect to survive for very long, because a gas monopoly is a revenue stream that goes on forever unless you sell it, in which case it goes away. It’s just crystal clear what the situation is from the eyes of the government of Greece at the present time. Now when they fail to sell the gas monopoly, then on six hours’ notice with no cabinet discussion and no parliamentary debate and no vote, they shut the state radio and television, ostensibly to save 200 to 250 million euros over the course of a year in order to satisfy an

173 arbitrary demand for that amount from the troika, and to show how tough and resolute they were. Well, the Greek people said, no, that’s enough. That’s enough. You can put up with a lot of privation, but you cannot put up with a direct attack on the one – however flawed – institution of public discourse that the country actually has. You can’t do it, so the journalists took over the buildings, the trade unions kept the power on, and the crowds went outside to protect them. It was fantastic. But it was something that really tells you you’re not far away from the brink. And there are more things that can and will happen over time, but you’re not far away from having a confrontation that will lead to a real, let’s say, breaking point. And, of course, we’ve already seen the political repercussions in the sense that the one of the coalition partners left the government, leaving it with a majority of three. And it does not take much for a majority of three to lead to new elections. RS: What was the mood actually in Greece. I mean, going through the streets, what did you see as physical evidence of the condition the country is in? JG: Well, there are two things. One is that in the streets of Athens you see elderly people prowling through the garbage looking for food. You see lots and lots of people sleeping on the streets, it’s a very depressing sight. You also see miles of empty storefronts. And you see pawn shops, chains of pawn shops, sometimes occupying the only viable business in an otherwise empty, rather ugly complex of former business showrooms and so forth. So that’s the kind of evidence you see palpably. The other thing that I saw was – again, outside the ERT offices – was rather more exhilarating, in fact, it was exhilarating, which was this atmosphere of – I wouldn’t call it even protest – we are here because we are going to protect, we are not going to allow this closure of state television and radio to happen, and so we are here to stand as a buffer between the staff who are inside going about their jobs and any coercive force that was outside, which was – mercifully at that point – not in evidence, but obviously a potential. If the crowds hadn’t been there, you know, you could have had… The government had told the trade unions to turn off the electricity, and they turned off the phones, but the trade unions said no, we’re going to keep the electricity going. The government turned off the broadcasting towers, but the staff hooked up with the web and broadcast that way. And other private radio stations across Europe took it up. RS: What about Portugal. You said at one point that there it wasn’t quite as evident at this point. JG: You had a general strike in Portugal, I think, yesterday. The Portuguese situation is very serious, but my sense, and I wasn’t there for very long, my sense is that the social stress is not as serious as in Greece. What will happen, is if the place is going to break, I think it will be Greece first, and that the problem after that, the immediate problem is not the same kind of social breakdown in Portugal, or Spain, for that matter, but that the speculative attack on those countries becomes overwhelming. You get a bank run, in other words. RS: Speaking of banks, the EU has apparently decided that it’s going to be a general policy now to start including depositors in the ones that take a beating when a bank fails. What do expect that to do. I mean, we’re still talking about uninsured deposits here. JG: The problem here is the scale of deposit insurance, and there are two things. One is the basic level, 100,000 euro, is too low. And the other is how you treat business entities, cooperatives, and small businesses and so forth, who have payroll, which periodically is a lot more than that. If you’re rigid about the question of whose deposits are insured, then you’re going to in this kind of a bail-in, you’re going to end up bankrupting your business sector, which is what has happened in Cyprus. Now, what happened in the U.S.: You don’t want to create a situation in which one hundred percent of all deposits are insured, as then it’s just an invitation for all kinds of, say, unscrupulous activity. I mean that what happens is that a bank offers a little more interest and 174 you have money flowing around all over the place. What you want to do is to have a solid base of deposit insurance and a base for businesses. And then, of course, people need to be aware that there are limits, which is again the situation. The test of it is that you want to avoid a situation in which there is a panic, a capricious run on the banking system, and I don’t think the Europeans are there. And, of course, the problem that they have is that if it’s the national authority that’s paying out, then the bankruptcy of the state basically means that the deposit insurance fund isn’t credible, this is why it has to be done on a collective basis. RS: There’s a lot of resistance to that here. JG: Well, that may be, but, you know, nobody is safe in this situation. RS: Well, Germans do worry about their deposits. They hear that deposits aren’t necessarily safe, it makes them worry, too. But they’re absolutely dead set against paying for anybody else’s. JG: I think that ultimately the decision on the future of Europe will be made in Germany, and Germany has to decide, does it want it or not? If it wants it, it has to take minimal steps to stabilize it on the same principles on which they stabilized the East, and on which they built the Federal Republic in the first place. And if they don’t want it, well, it will go away. RS: I think even if they want it, they’re not going to stabilize it. JG: In which case they’ll lose it, and then we can see what is left. But when it’s lost, Germany’s going to have the problem it had before of an appreciating currency, and an industry that quickly loses competitiveness, and there’ll be higher unemployment. And its markets will have collapsed and its debts won’t get paid. Germany is not going to escape the consequences of this. Again, it’s a choice that Germans can, and I’m sure, will make. But what is necessary is to state clearly what the choice actually is. This is why Yanis Varoufakis and I made the argument in the New York Times that a Syriza government in Greece is perhaps the best hope for Europe, because it would present the choice clearly. Syriza is a pro-European party, it’s not proposing in a reckless way to take Greece out of the Euro, which the Greek people don’t want to do. RS: They’re being accused of that. JG: It’s a false accusation. Syriza is a pro-European party. RS: You’ve met with Tsipras? JG: I’ve met him several times, yes. Actually, we met up with him in the ERT offices in Thessonloniki, and that was quite a dramatic moment. It’s interesting to watch someone in a moment like that, which has a lot of emotional charge to it. As a political presence he’s very impressive. It’s the first time I’d seen him in that situation, and I was very struck by it. RS: Well that [a Syriza government] could happen sooner than we think. The government continues to crumble there, I mean, three votes… JG: …three votes, yes. And the initial thinking was that Samaras had done this in part because he figured that he would win either way, either coalition partners would be forced out, in which case he’d get an early election, or they would cave, in which case he would be completely dominant inside the coalition. RS: I think he didn’t figure the people would be upset about it given the reputation… JG: That is what Alexis said to me, that they miscalculated the reaction of the people. But from the people’s point of view, if you look at the alternatives that are available with commercial channels, foreign channels, the Greek Orthodox Church channel, you end up not having a national media. You don’t have anything which has got the responsibility of conveying what’s going on in the country to the population. So that’s unacceptable.

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RS: A difficulty that can be, is that, of course, it can become a state media in the negative sense. JG: Of course, and the ERT had all kinds of problems… RS: …the government’s mouthpiece… JG: …well, yes, yes, and Yanis Varoufakis was banned from it. One reason we went to Thessaloníki – we went for a meeting on economics, but also had planned to have an interview with ERT 3, which was the only branch that didn’t get the memo that they couldn’t have Varoufakis. So, yes, there were all kinds of issues here. But interestingly enough, when we went to the building in Athens the right-wing journalists were there, too. I mean, this crossed a line. You have the basic institutions of a functioning self government or not. That’s as simple as that. It created a great deal of clarity. People understood this was not an austerity move, this was a political act. RS: Do you think Greece is going to collapse? JG: Well, the current direction is certainly moving that way, and moving that way, I think, quite quickly. And I think the precipitating event will probably be political. We’ll see what happens when there’s a change of government. If I were in a position to counsel European authorities, which I do from the margins, I would say, you need to rethink your ideas quickly. Time is not on your side on this issue. RS: I’m sure you’ve been in touch with Heiner Flassbeck. JG: I saw him two days ago. RS: His take? JG: Heiner and I see eye-to-eye on a lot of things. I think my policy approach is where there are some differences. I put much more emphasis on social insurance, he puts it on wages. The social insurance in my framework, the advantage of it is if you wanted to do it, you could do it very fast. You’re not changing labor relations. RS: The problem is that it appears that we’re going in exactly the opposite direction right now. JG: I fully understand the direction we’re going in, but my job is not to be the political realist, my job is to be the economic realist. What I’m trying to lay out is what seems to be the minimum necessary steps to prevent the failure of the system. And I really think that’s just minimal. The idea is to do as little as you need to do, and to do it within the framework of current European treaties insofar as you can, because there’s a lot of grand talk about banking unions, new federalism and so forth, and the patient will be gone long before you get there. You can erect that over the grave. RS: Well, I think that to some extent it’s a way of pushing things off into the future. JG: That’s exactly right. But pushing things off into the future in the present situation is a formula for absolute failure. RS: That’s clear, but I don’t think it’s clear to everyone yet. There’s been the initiative, as well as this pact for competitiveness that Merkel started. JG: The idea that you’re going to have a successful European Union which is competitive in labor costs for the Chinese is a… RS: …pact for lower wages, and to eliminate social… JG: …reductio ad adsurdum. No chance of succeeding along those lines. None. RS: But I fear that it may come, though. Whether it’ll succeed or not is not the issue here. JG: Yeah, sure. And it raises the question of what the real motivation behind such a scheme actually is. Is this simply something that’s a political document designed to appease a certain constituency, or is it largely just another attack on contrary political forces, on labor and so

176 forth. And I’m sure that’s partly true, as well. But what it is not is an even remotely credible document for an economic strategy. RS: It’s an ideology, and public opinion here as represented in the media is that the rest of Europe should become more like Germany. JG: It’s fair to characterize how the media represent things, but an underlying fact is that the German Federal Republic was built in the postwar years on social democratic principles, and I imagine a large part of the German population still shares those principles. RS: Very much so. JG: The German trade unions, with whom I have good relations, have, I think, staked out one of the most progressive positions, and I think they are in Europe the force that’s most alive in northern Europe to the conditions outside the core countries. So if there is going to be a rescuing of the European project, it will be here. I’m confident it will not come from France, and the other countries of the north are too small. So there it is. It’s Germany or nobody to make a change of ideas and policies. RS: Well, the opinion leaders, as we might call them, are going to have to change their rhetoric before that’s going to happen, because they’re still very much in the other direction. JG: I agree. Or new opinion leaders need to emerge with a different rhetoric, so there you are. RS: They’re not there. JG: Well, I understand, but that doesn’t mean that they can’t be created. You know, the project forlorn and hopeless as it may be of someone like me is to try and express ideas that can be crystallized into an alternative program. I can’t do implement that program, I’m not German. It has to be done in here, but I can certainly visit from time to time and open my mouth, which is what I do. RS: It doesn’t hurt… It would be nice to have some sort of a force. The social democrats do criticize that the austerity-only program isn’t working. But they don’t really take that step far enough in the other direction. JG: There’s a large political class out in Brussels, well-meaning people with utopian visions. They’re not getting out as much as they should, to see what is actually happening. And there’s a tendency to think that, well, Greece is a long way away, and the rest of us will not be affected if Greece goes down. But I say, show me an example of a political union, of a confederation, that holds together when a piece of it goes away. The United States… RS: That was tried… JG: Well, what precipitated the secession of the South in 1860 was the departure of South Carolina. That was the first, and then… But to bring it into the 20th century, Yugoslavia fell apart following the departure of one Republic, which was Slovenia. And the Soviet Union fell apart following the departure of the Baltics, which were tiny in relationship to the whole. Once a piece of an entity like this is kicked out, you have cumulative processes which can operate very quickly, very quickly. RS: You do have the problem here that you have countries, and they have a national identity. That doesn’t make them nationalistic… JG: Right. But one needs to recognize that you have a project which has built up a standard of living of the European continent, and that’s a project of integration. Integration has a lot of efficiencies associated with it. In any event it creates a world in which there are cross-border

177 interdependencies. And if you want to break them up, you can, but the price is enormous. In the experience that we’ve had recently, it’s on the order of 40%. So that’s a good benchmark for what might happen to living standards if you suddenly went back to capital controls and trade barriers and national industries. And good luck trying to build national industries that will compete with the industries that will be in Germany that are highly competitive, but will not have markets because nobody will be able to buy their goods. RS: Right. There’s also the notion of nations competing against each other the way companies compete against each other, which is fairly strong here in Europe. JG: There’s that, and then the notion that Greece has a formula that will restore its competitiveness. There’s a misunderstanding of what the Greek economy consists of. The number one industry is shipping, number two is tourism. Shipping is a world phenomenon that depends entirely on the movement of goods and services around the globe. And tourism is entirely dependent on, among other things, the Germans and the British. RS: What’s the attitude about Germans there? What I read in the papers here, it’s actually mixed. You sometimes read about the Nazi symbols and all that sort of thing. At other times – there was a picture about a year ago of people holding up a thing saying, “Thank You, Europe”, which happened to be people who were thanking people in other countries for protesting against the austerity measures, and it was twisted the other way around. So you get a little bit of both kinds of stories as to what the attitudes there are. JG: Greece is a highly polarized country, and as the situation gets desperate, you have a Neo- Nazi party which is using food, among other things, as a political organizing tool, food and xenophobia. People who have talked to the immigrant communities report that they’re very frightened, very frightened. I saw Tariq Ali in Rome late last year. He’d been speaking to the Pakistani community in Greece, and he said these are people who have been really intimidated. There are a lot of immigrant communities in Greece, and they’re targets and they know it. RS: I was going to ask you about a totally different subject: your talk today. The title of it sounded interesting, but I’m not sure what it means. I’m curious as to just what that was about. JG: Well, it was not that separate from what we’ve been talking about, it came around to that. RS: The title certainly implied something completely different. JG: No, it wasn’t completely different at all, but I used it as a way of saying, what is the inverse relationship between bandwidth and understanding in Transatlantic communications. In the days before the telegraph, Europe at least one newspaper correspondent who understood the United States rather well, and his name was Karl Marx. He’d never been to the United States, but was a good reader of maps, knew where the railroads were, knew where the mountain ranges were, knew what the political environment was, knew the census reports and the proportion of slaves and free labor in each of the states of the South and the border states. And because he thought clearly and independently about these issues, he was able to write very clearly about the nature of the Civil War, about Abraham Lincoln’s approach, and about the likely military outcome, what a victory of the South would have required and how it quickly became a military impossibility. So it’s very bracing to read Marx on the U.S. Civil War, and particularly in comparison with the mythologized textbook treatments that one gets even now after 150 years. How does that bear on the modern world? The argument I made was that the dominant European narrative of the United States now as then is utterly misleading. It’s the notion that we have somehow in the thirty years since Ronald Reagan transformed ourselves into a free-market, deregulated, privatized, flexible labor market, weak-welfare-state country, which, if you just cast your memory back to the 60′s and 70′s, a totally unrecognizable view of the country, a country that was built by Roosevelt and Kennedy

178 and Johnson, especially Roosevelt and Johnson, and which had extended even into the Nixon administration, which had and has a very substantial social insurance, public investment and regulatory framework. Many things about this have been under assault, some of them have failed entirely, including the regulation of finance, but this is not a Hayekian vision that has triumphed, but rather the one I described in my book, The Predator State. The real politics of the country controls these apparatuses and how much of the benefits are diverted to cronies and oligarchs and political constituents, which captures what happened in the Clinton and the Bush years – and ongoing, of course. RS: Well, that’s good for them to hear, because, that is something I face, particularly from the left. There is the view that the United States is the epitome of unsocial, and the attitude in the United States about Europe is just the other way around. JG: That was the premise of my talk. And it’s interesting that since these two reciprocal images serve the purposes of both the right and left on both continents. They are not challenged by either side, and therefore there’s never a real corrective on the table. So that was, the goal of my talk was to make exactly that point. RS: I’m glad somebody’s saying that. I get tired of saying it. http://www.nakedcapitalism.com/2013/07/james-galbraith-on-social-breakdown-and- financial-stress-in-europe-and-why-the-word-stimulus-needs-to-be-banned.html

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ft.com World Europe

July 30, 2013 10:24 pm Milder than expected final terms for Cyprus bail-in unveiled By Kerin Hope & Andreas Hadjipapas in Nicosia

©EPA A woman walks past a Nicosia branch of Bank of Cyprus The Cyprus government and central bank on Tuesday announced milder than expected final terms of a bail-in for uninsured depositors at Bank of Cyprus but signalled it could take years before their remaining funds are fully unfrozen. Deposits above the guaranteed limit of €100,000 will face a 47.5 per cent haircut, while an additional 5 per cent of total deposits would be made available for withdrawal by account holders on top of the 10 per cent already returned in cash, according to a joint statement by the finance bank and the central bank. More ON THIS TOPIC/ Former Cyprus defence minister guilty/ Cyprus seeks to ease bailout terms/ Cyprus leader calls for bailout overhaul/ Cyprus to crack down on graft IN EUROPE/ Bayern chairman charged over tax evasion/ Supreme court starts Berlusconi appeal hearing/ Spanish death crash driver was on phone/ Athens signs delayed lottery deal “This development brings to an end an extended period of uncertainty,” the statement said. Bank of Cyprus will have a core tier one capital ratio of 12.5 following the bail-in, compared to a minimum of nine required by international lenders when the three-year bailout programme comes to an end. The unprecedented bail-in of depositors was agreed with the EU and International Monetary Fund as part of Cyprus’s €10bn emergency rescue in March. At that time account holders feared they would lose as much as 60 per cent of their funds after the government announced a 37.5 per cent haircut of uninsured deposits and placed another 22.5 per cent in an escrow account to cover unspecified future needs. Depositors will receive shares in a slimmed down Bank of Cyprus as part of the bail-in and will earn interest on funds still frozen, which will be placed in six-, nine and 12- month time deposits with the bank retaining the right to roll them over.

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Christopher Pissarides, the Nobel Prize-winning Cypriot economist who is advising the government, said it could take up to two years before the eurozone’s first controls on capital movement, which were imposed in March, are fully lifted. The bail-in would wipe out about €8bn of deposits while still leaving Bank of Cyprus as the island’s largest lender. Bank of Cyprus acquired some assets from Popular (Laiki) Bank, the second-largest, which was shut down as part of the bailout agreement. Former depositors in Popular Bank would hold about 18 per cent of Bank of Cyprus, followed by Russian and Ukrainian companies represented by prominent Cypriot lawyers, among them President Nikos Anastasiades, with about 16 per cent, according to unofficial estimates. Andreas Neocleous, a Limassol-based lawyer with a sizeable number of eastern European clients who kept funds in Bank of Cyprus, said: “They [the clients] felt bitter and angry at the way their money was seized . . . but can now look forward to making something back in the future if the bank’s share price goes up.” http://www.ft.com/intl/cms/s/0/85eb3cea-f943-11e2-a6ef- 00144feabdc0.html#axzz2aWmEE0WC ft.com Companies Financials Banks July 30, 2013 7:36 pm Banking duo sing from same hymn sheet By Daniel Schäfer and Sharlene Goff

©Bloomberg Barclays’ Antony Jenkins (left) and Deutsche’s Anshu Jain must transform the culture at their banks Anyone who listened to both Barclays’ and Deutsche’s analyst calls on Tuesday may have thought that there was a strange echo on the phone lines into London and Frankfurt. The bank’s two bosses seemed to be using the same management buzzwords: it was all about “costs”, “capital” and, above all, “leverage”. It was, perhaps, to be expected. This week, it became more apparent then ever that Antony Jenkins, Barclays’ chief executive, and Anshu Jain, Deutsche’s co-head, face similar uphill-struggles – around a year after taking the helm at their respective banks. More ON THIS STORY/ Robert Jenkins Don’t buy the Barclays hype/ Big banks strive to bolster risk funds/ Barclays reveals £12.8bn balance sheet hole/ Deutsche to cut balance sheet by €250bn/ Jenkins v Jain – rivals face similar struggles ON THIS TOPIC/ Bank’s cash calls during 2008 resonate/ Surprise rights issue drags down Erste/ FirstGroup downgrade threat to rail bidding/ Arabtec launches aggressive finance plan

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IN BANKS/ Liechtenstein bank settles US tax case/ Tourre trial told of ‘land of make believe’/ RBS faces up to £4.36bn in claims/ Barclays chief’s halo slips

These two “AJs” have been working to clean up the many legacy issues left behind by their predecessors: from insufficient capital, to legal scandals, and strategic deficiencies. And this week, they both moved to address what has been one of the most pressing problems for both of their banks: a high debt load in relation to overall assets. But while the challenges facing Barclays and Deutsche are similar, the routes they have taken to address them have been notably different. Barclays’ plan – unveiled on Tuesday along with its first-half results – is centred around a larger than expected £5.8bn rights issue, supported by moves to shrink its balance sheet by a moderate 5 per cent and issue £2bn of contingent convertible debt. Deutsche, on the other hand, has opted for a far more aggressive asset reduction plan. Mr Jain said the bank would reduce its balance sheet by up to €300bn in the next two years – stripping out a fifth of its total asset base – after launching a smaller €2.95bn equity raising in April. These different approaches are largely due to timing. The UK regulator recently imposed a much tougher timetable for Britain’s banks to meet a new leverage ratio requirement, leaving Barclays less than 12 months to boost its equity to a level equal to 3 per cent of its overall assets. Initially, the bank had been expecting to hit the 3 per cent leverage ratio in 2015 – a deadline that Mr Jenkins believes he could have met without having to raise equity.

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However, in recent weeks, Barclays was told by the Prudential Regulation Authority that the deadline would be brought forward to June 2014 – leaving it little option but to raise fresh funds, and fast. At the same time, a recalculation of the PRA’s leverage ratio, using new European definitions of capital, left Barclays in a weaker position than it appeared just a few weeks ago. Under the new measure, its stressed leverage ratio dropped to 2.2 per cent at the end of June, compared with the 2.5 per cent number reported by the PRA last month on the basis of older figures. Under the PRA’s new leverage criteria, Barclays said it was facing a capital shortfall of £12.8bn – much larger than the £7bn analysts had expected. Mr Jenkins, who irked the regulator last month when he warned that forcing the bank to meet an accelerated leverage ratio deadline could restrain lending, on Tuesday stressed the “constructive” nature of its discussions with the PRA. He highlighted the benefits for investors, saying that the capital raising – together with a newly conservative position on provisioning for mis-sold loan insurance and interest rate swaps – brought much needed certainty on capital and conduct risk. “The question mark in the minds of investors has been around capital and conduct costs – these actions are designed to reduce that uncertainty,” he argued. The new chief executive could not, however, gloss over the fact that the tougher capital demands meant he would have to delay by a year a key pledge to drive up returns to above the bank’s cost of capital – about 11.5 per cent – just five months after he had set the target. Analysts at Citibank said that “simply applying the mechanics of the rights issue would result in a decline in our 2015 return on tangible equity forecast from 13 per cent to 11.3 per cent.” They noted that this was “in line with Barclays’ expectation for return on equity to now exceed cost of equity by 2016, instead of the original 2015 target”. For Deutsche, its balance sheet shrinkage plan will cost €600m in one-off expenses in the next 18 months and will chip €300m off its future earnings before interest and tax from 2015, according to Stefan Krause, its chief financial officer. It is the final part of Mr Jain’s plan to address a particularly weak capital position. When he took office a year ago, Deutsche was lagging behind its global rivals with a core tier one level of merely 5.9 per cent. Within 12 months, however, a combination of changes in its risk models, retained earnings and a €2.95bn capital raising exercise in April had catapulted Deutsche from a laggard to one of the world’s strongest capitalised banks. Its core tier one ratio, now 10 per cent, already matches its 2015 target. Its actions, combined with the balance sheet shrinkage, will help lift Deutsche’s leverage ratio to 3.6 per cent by 2015 under the European version of the incoming Basel III rule book. Mr Jain and Mr Jenkins clearly believe there are different ways to improve low leverage ratios. But, the outcomes – like their conference call utterances – have resonated in a similar way with shareholders: Barclays’ shares fell by 6 per cent to 290.6p on Tuesday, while Deutsche’s dropped more than 4 per cent to €34.4. http://www.ft.com/intl/cms/s/0/e63224a8-f919-11e2-a6ef-00144feabdc0.html#axzz2aWmEE0WC

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07/30/2013 12:51 PM Interim Profit Down Deutsche Bank Suffers New Setback Deutsche Bank reported lower-than-expected profits for the second quarter on Tuesday, underperforming US rivals like Goldman Sachs and Morgan Stanley. Earnings suffered because more funds went to covering the costs of lawsuits against the bank. Deutsche Bank has reported that it earned less than expected in this year's second quarter, posting a pre-tax profit of €792 million ($1.05 billion), down 18 percent year- on-year and 67 percent less than in the previous quarter. Analysts had predicted a profit of more than €1.3 billion. The drop was caused by further provisions set aside for lawsuits against Germany's largest bank, which had already set aside some €2.5 billion for litigation risks resulting from a case brought by the Kirch media group, and others involving the Libor rate fixing scandal and mortgage deals in the US. Now it's increasing that amount by a further €630 million. Net profit totalled €355 million, about half as much as in the weak second quarter of 2012 when the euro crisis hit earnings from investment banking. Deutsche Bank's investment banking earnings rose by around 10 percent in the second quarter, but fell well short of the dream results earned by its US competitors. Outperformed by US Peers By comparison, Morgan Stanley, Goldman Sachs, JPMorgan Chase & Co and Bank of America Corp have all beat analysts' profit expectations for the second quarter, thanks largely to strength in investment banking. News of Deutsche Bank's poor second-quarter performance pushed its shares down as much as four percent in early trading on Tuesday. "In the second quarter our core businesses performed well, our franchise remained strong, and we continued to reconfigure our platform to serve our clients more effectively," co-chief executives Anshu Jain and Jürgen Fitschen said in a statement. They referred to a new code of conduct presented to their 100,000 staff last week in a bid to bring about cultural change in the bank, whose reputation has suffered from scandals, fraud allegations and accusations of reckless profiteering that contributed to the financial crisis. "We took an important step toward our objective of placing Deutsche Bank at the forefront of cultural change with the launch of our new values and supporting beliefs," the CEOs said. "In the months ahead, together with our senior leaders from across Deutsche Bank, we will work on embedding these values." Deutsche Bank also said it planned to reduce its balance sheet to help it meet requirements on its so-called leverage ratio -- a measure of indebtedness that supervisory authorities plan to focus more heavily on in future. The bank has identified €250 billion worth of assets to cut in a bid to meet new bank safety rules.

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cro -- with wire reports URL: • http://www.spiegel.de/international/business/deutsche-bank-reports-fall-in-second- quarter-profits-a-913836.html Related SPIEGEL ONLINE links: • EU Banking Deal Why It Will Be Ignored in Times of Trouble (06/27/2013) http://www.spiegel.de/international/business/0,1518,908251,00.html • 'Perpetuating Blight' Deutsche Bank 'Slumlord' Case Going to Trial (04/25/2013) http://www.spiegel.de/international/business/0,1518,896481,00.html • A Reputation in Ruin Deutsche Bank Slides into a Swamp of Scandal (12/19/2012) http://www.spiegel.de/international/business/0,1518,873544,00.html • Litigation Risks Deutsche Bank Faces a Series of Damaging Lawsuits (01/30/2012) http://www.spiegel.de/international/business/0,1518,812212,00.html

Daily Morning Newsbriefing

July 30, 2013 Is the Italian economy about to improve? Italian business confidence rose in July to 79.6 points, up from 74.6 in June, ISTAT said. As La Stampa reports, the manufacturing confidence index rose to 91.7 from 90.5, while the assessment of order books and production expectations improved from -39 to -37 and from -2 to 0, respectively. Also the market services confidence index rose despite a decrease in tourism index. According to the paper, the data signal a recovery in economic activity from September. The data suggest that the worst could be over for manufacturing sector, but there are still downside risks due the political uncertainty. Bank of Italy investigates NPLs The Wall Street Journal reports that the Bank of Italy will investigate the non- performing loans of Italian banks, estimated at about €250bn (14.2% of overall loans) at the end of March. The Bank of Italy expressed concerns over a shortfall of capital ratios and could ask to lenders to adopt intensive measures to rebalance their portfolios, such as asset sales or recapitalisations. According to the document unveiled by the WSJ, the Bank of Italy reviewed €3.4bn of loans last autumn, but now wants to extend the operations. Fabio Panetta, the BoI deputy general director, told the WSJ that the central bank is aware of the concerns by international investors. The investigations are expected to be concluded later this summer, according to the paper. Spanish unit labour costs drop slightly for the first time Spain's National Statistics Institute INE released its annual labour costs survey. The gross cost per worker was just under €31k, including government subsidies to foster employment which added up to less than 1% on average. Gross wages averaged nearly

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€23k, with most of the rest (nearly €7k) corresponding to social security contributions. The unit labour costs dropped by less than 1% from a year earlier, which El País writes is the first decline since the start of the survey in 2001. Greece’s 2013 privatisation target lowered Greece's lenders lowered the country's privatisation target from €2.6bn to €1.6bn for this year and raised it for the next from €1.9bn to €3.5bn Reuters reports. "After missing the end-December 2012 target for privatisation proceeds by a wide margin, targets for 2013 will most likely also be missed, even though it might be possible to recoup them in 2014 if efforts are redoubled," the EU said in the report. The sale of a government stake in refiner Hellenic Petroleum HEPr.AT was pushed back to the third quarter next year, after a renewed attempt to sell DEPA, the document showed. Separately, bank-bailout fund HFSF will sell a "substantial stake" in lender Eurobank by end-March 2014. Next aid tranche to Greece approved Greek lenders approved the disbursement of a combined €5.7bn aid tranche on Monday, Kathimerini reports. The IMF board met last night to approve the release of its €1.7bn share in the latest Greek bailout tranche. The IMF’s green light came a few hours after Germany’s parliamentary budget committee also cleared the way for Athens to receive €2.5bn from the EFSF. Last Friday, eurozone officials already decided that Greece has finally met its 22 targets, parliamentary approval was the final step. Greece will get another €1.5bn from eurozone central banks from profits made over Greek bond purchases. The money will go into a special account at the Bank of Greece, from where some €2.2bn will be used to pay bonds that mature in three weeks. Portugal’s corporate tax reform to benefit international companies If the corporation tax reform proposals made by Xavier Lobo’s committee were to be implemented Portugal would become a very attractive country for international companies with taxation conditions in place that allows capital to flow in and out of the country without taxation. In Portugal based companies could receive dividend or capital gains payments without paying taxes if a set of minimum criteria is fulfilled, which are quite favourable if compared with the ones in place in Luxembourg or the Netherlands. It would also become much easier to get money out of Portugal without taxation at source, more at Jornal de Negocios. Another plagiarism scandal hits the CDU The CDU is riding high in the polls, and the opposition has so far failed to make any dent despite various scandals. We doubt this latest scandal is going to make any difference either, but it comes at a bad time, and it affects one of Angela Merkel’s closest political allies, Norbert Lammert, president of the Bundestag. Die Welt reports that an anonymous author has published a documentation of Lammert’s PhD thesis, which purports to show serious flaws with his PhD’s thesis in political science. Two ministers have already resigned over plagiarism revelations. Lammert has now asked his university to investigate the thesis, which he wrote in 1975. The anonomyous documents of the errors has been published on the internet page lammertplag.wordpress.com –behind which stands the same anti-plagarism activist who last year forced the resignation of Annette Schavan as science minister in Merkel‘s cabinet. In the case of Lammert, the problem is not only that he copied text passage without attribution, but that he also copied mistakes, and that he faked a scientific discourse.

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Germans pay down credits Spiegel Online has the story that the Germans paid down credit during Q1 despite the record low interest rates, according to data from the Bundesbank. Especially consumer credits have been paid down. The total household debt ratio went down by 0.2% to 59%. The data also reveal an increase in overall household wealth by 1.1% during the first quarter, mostly tilted towards the upper end of the income scale, with the richtest 10% of households owning over 50% of all the net wealth in the country. WSJ on Germany The Wall Street Journal is taking a critical look at the economic performance, which looks strong relative to other eurozone countries, but beneath this strength, there are underlying problems. The article says that Germany’s growth potential may not be as high as is often states, as the economy is held back by low investment, down from 20% of GDP in 1999 to 17% today) , weak labour productivity growth, and a shrinking population. With near-full employment it may be hard for Germany to deliver non- inflationary growth. The article made the point that the much praised labour reforms had the effect of inducing firms to hire more labour rather than to invest with led to a large increase in the low wage sector. More recently, gross fixed capital formation has been declining for five consecutive quarters, resulting in a level of investment spending that is almost 5% lower than at the end of 2011. How to share risks Olivier Garnier argues in the FT that a fiscal union is not the only, or even the main instrument of risk sharing in a functioning monetary union. He noted that in large federations the largest absorber against state-specific shocks is cross-ownership of equity capital. That, unfortunately, is low in the eurozone as well. He said the advocacy of market-based risk sharing mechanisms could appear counterproductive since cross-border private financial flows have a cause of the crisis. But he says the problem is not the presence of flows as such, but the wrong kind of flows – uphill flows as he calls them – with Germany being a net important of equity capital from the rest of the eurozone. He advocates financial integration by enhancing cross-border capital ownership of banks and corporates as one way of strengthening the resilience of the eurozone. This is not possible at present, given the obstacles both in the periphery and the core. He makes a number of proposals how to bring about such a change, such as debt-to-equity conversions, and means to channel Germany’s current account surplus into equity holdings. All good, we agree, but it is hard to see how you can force private sector equity flows without a central government. What he is proposing is a lot more intrusive than a eurobond. The main reason equity is predominately national lies with fragmented legal and supervisory systems. You will not get Germans to put equity into a Spanish bank for as long as the Spanish state is ultimately responsible for the banking system. It would take a significant degree of legal harmonisation and political centralisation to achieve those private sector fund flows. What he describes is an ideal state of affairs to which the eurozone may converge in 20 or 30 years, but this is the stuff that happens after the eurobond and the joint deposit insurance. Galbraith on Greece In an interview with Suddeutsche Zeitung, James Galbraith says the eurozone is on the verge of another acute phase of its crisis – and he predicts that without OSI Greece cannot stay in the eurozone. What struck us was his observation that Greece is about to

187 sell its gas monopolist – a money printing machine with state revenues and profits. Only a government that no longer believes in its own future would sell such a company. He says he does not know when Greece will collapse, but he says the mechanism will be a bank run, because Greece is heading towards a Cyrpus-style bail-in of deposit accounts. He says the only policy to avert a catastrophe would be a large scale restructuring in official debt, and an EU investment programme. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.614 0.614 0.608 Italy 2.746 2.790 2.789 Spain 2.924 2.980 2.974 Portugal 4.803 4.807 4.858 Greece 8.467 8.460 8.45 Ireland 2.222 2.233 2.231 Belgium 0.903 0.889 0.886 Bund Yield 1.664 1.665 1.666 Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.328 1.3255

Yen 130.120 130.35

Pound 0.862 0.8647

Swiss Franc 1.233 1.2336

ZC Inflation Swaps

previous last close

1 yr 1.5 1.39

2 yr 1.45 1.34

5 yr 1.6 1.47

10 yr 1.94 1.8

Euribor-OIS Spread

previous last close

1 Week -6.171 -5.571

1 Month -2.957 -2.557

3 Months 3.714 3.814

1 Year 30.529 30.929

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-07- 30.html?cHash=f2820f326dcca07607fe6d5db2b18cdb

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ft.com/markets MARKETS INSIGHT July 29, 2013 9:12 am Markets Insight: Cross-border equity ownership is key to eurozone risk- sharing By Olivier Garnier The eurozone has been suffering ‘mal-integration’ According to the new “Brussels consensus”, the only viable solution to lower the risk of balance of payments crises within the eurozone is by moving closer to fiscal union. There is little doubt that cross-country risk-sharing is required in a monetary union. But it would be ill-advised to rely on mutualisation mechanisms through fiscal transfers only, as opposed to market-based mechanisms. In large federations such as the US or Germany, the federal budget is neither the sole nor even the main channel of risk-sharing among states. Indeed, studies show the largest absorber against state-specific shocks is cross-ownership of equity capital, far ahead of the federal tax-transfer system. More ON THIS STORY/ FT series Europe – Make or Break/ FT series Future of the euro/ ON THIS TOPIC/ The Macro Sweep UK, US, Turkey/ Martin Sandbu Europe should let go of hopeless causes/ Global Insight Paralysis may extend past German election/ Editorial Europe risks the ‘wrong’ kind of recovery MARKETS INSIGHT/ Lower fertility rates threaten tax base/ Case for investing in EM still intact/ Motown’s screech will be heard in Europe/ Bailouts can turn a profit for lenders Advocating increased reliance on market-based risk-sharing mechanisms could appear counterproductive since cross-border private financial flows have exacerbated the boom and bust in periphery economies. However, the eurozone has been suffering from “mal- integration”: flows from the core to the periphery largely took the form of debt, as opposed to direct and equity investment. Meanwhile, equity capital has been flowing “uphill”: over the past 12 years, Germany has been a net importer of equity capital from the rest of the eurozone. As a complement to banking union, it is thus key to promote a genuine and complete financial integration by enhancing cross-border capital ownership of banks and corporates. In theory, this process should take place spontaneously through market mechanisms. In peripheral economies, the fall in share prices and labour costs should create attractive investment opportunities for core country companies and investors. In practice, however, this process is hindered by many obstacles both in the periphery and in the core. Therefore, more centralised solutions combining private and public funds are necessary, at least as catalysts in the initial stage of this process.

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First, the European official sector could help in restructuring the foreign liabilities of peripheral countries by a sort of debt-to-equity conversion. So far, financial assistance to member states has been provided through loans, thus adding to their debt burden. As a result, a substantial share of the periphery government debt is now held by governments and international organisations. Exchanging debt for equity would be an alternative to official sector involvement, providing immediate and substantial relief to periphery states while being more acceptable by core states than “voluntary” debt haircuts. This could be done by establishing an agency in charge of buying, restructuring and privatising state-owned assets. Stronger expertise, political independence and a longer time span (10-15 years, thus preventing “fire sales” and giving time to restructure assets), would make this agency more effective than existing national privatisation schemes, which have so far achieved disappointing results. Second, a greater share of the structural German external surplus should be recycled through direct and equity investment in the rest of the eurozone. By lending its excess savings to the other eurozone members, Germany has been able to accumulate record- high current account surpluses without facing the risk of exchange rate appreciation and currency losses on foreign asset holdings. But the debt crisis has been a brutal reminder that credit risk replaces exchange rate risk within a monetary union. As a result, German private capital outflows have reversed, while deposits at the Bundesbank have surged. In other words, German excess savings are now primarily intermediated by the eurosystem. There is no doubt that this form of recycling is suboptimal, including for Germany. On the one hand, German savers accumulate domestic bank deposits earning zero nominal return. But on the other hand, as taxpayers they remain exposed to peripheral credit risk. Wolfgang Schäuble, Germany’s finance minister, said recently: “We want to show that we are not just the world’s best savers.” Recent bilateral arrangements with peripheral countries might be seen as a first step in this direction but KfW, the German state bank, will primarily provide loans instead of capital to small business. A more ambitious idea would be to create a German long-term investment vehicle funded by both private and government savings (or benefiting from a government guarantee), and designed to take equity stakes in periphery economies. The involvement of government money would be key to entice risk-averse German savers. Such asset property transfers would face major political obstacles, especially in the periphery. But bear in mind that hurdles to fiscal union would be much higher. Olivier Garnier is group chief economist at Société Générale http://www.ft.com/intl/cms/s/0/efda751e-f3ab-11e2-b25a- 00144feabdc0.html#ixzz2aTFcrqfb

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ft.com Comment Opinion July 29, 2013 7:39 pm Bernanke did well, but the Fed must do better By Mike Konczal The lesson from the Great Recession must be that policy was too tight, writes Mike Konczal

©Bloomberg Who will replace Ben Bernanke as the next Federal Reserve chairman? This question has been dominating dinner tables in US political circles, with news that the administration is considering the former Treasury secretary Lawrence Summers for the role. But what has been less debated is precisely what the next incumbent will need to accomplish. Monetary intervention is one of the more complex areas of public policy, but a simple children’s story can summarise what awaits the next chair. They will need to answer the important Goldilocks question: was Mr Bernanke’s response to the Great Recession too hot, too cold or just right? More ON THIS STORY/ Obama description of ideal Fed chair suggests Summers preference/ Editorial What the Federal Reserve needs/ Senate letter backs Yellen for Fed role/ Dollar falls on fears of dovish Fed/ FT Alphaville Why Yellen should be the next Fed chair ON THIS TOPIC/ Battlelines drawn on Fed chair decision/ Record sums poured into leveraged loans/ Bonds to benefit from ageing population/ QE tapering requires delicate timing IN OPINION/ Bjorn Lomborg Green but cheaper fuels required/ Ranjani Iyer Mohanty India’s child labour/ Anatol Lieven Criticise Putin but don’t back his rivals/ Stian Westlake New lenders deserve Church’s blessing The next candidate for the Fed post will come under intense political scrutiny, especially from the conservative movement, over the idea that Mr Bernanke did far too much. It would be troubling if his successor were to agree: the year-over-year inflation rate is the lowest in 50 years, while unemployment still remains high at 7.6 per cent. The right answer is surely that Mr Bernanke deserves credit: as a scholar of the Great Depression facing an economy on the verge of collapse, he acted aggressively where

191 others might have frozen. Postmortems of his tenure should note his bravery and ingenuity. Facing a hostile new wave of Republicans after 2010, he argued against premature austerity and defended his unconventional actions to Congress and directly to the press. Thanks to him the US fared better than Europe. But, for all that, the policy regime Mr Bernanke has created cannot be considered “just right”, and cannot be the status quo in future. Since the policy rate, the Fed’s main instrument, has hit zero, the central bank has embarked on what has been called “unconventional policy” to continue supporting the economy. This includes the purchasing of assets such as mortgage-backed securities, agency debt and longer-term Treasury debt on a large scale. The Fed buys up safe assets, which both cuts yields and drives investors to hold riskier assets (the so-called “portfolio” effect). It has also managed expectations, targeting policy to future economic conditions. This culminated last year with so-called “QE3”, which consisted of open-ended monthly purchases of $85bn in assets until either inflation hit 2.5 per cent or unemployment hit 6.5 per cent: a measure that both seeks to work through the portfolio effect and to manage market expectations about future policy. Economists are debating the effects of these moves. But as a way of executing monetary policy, the strategy is not sustainable. Policies that require tying the Fed’s hands to keep rates low for an extended period of time can come apart if the economy recovers faster than expected. This is why there have been sudden sell-offs in response to suggestions of news from the Fed – investors do not quite trust that, if it comes to it, the central bank would honour its old commitments. Furthermore, the policies are far too reactive. Mr Bernanke’s decision to enact QE2 in the autumn of 2010 came after a long summer when there were massive concerns about a double-dip recession. That worry went away after QE2 began, but just the fact that the economy went through so much pain means it is far from an optimal policy. If the status quo is unsustainable, it will change. The question is whether it changes in the direction of a more concerted effort to maintain full employment and price stability, or whether the Fed gives up or plays down its dual mandate to target both prices and unemployment. Given that Mr Bernanke’s policies were not “just right”, where does that leave the Goldilocks question? His policies were too cold. There needs to be a regime shift in favour of a more permanent change in policy. This might mean a higher inflation target in the order of 4 per cent. Or the Fed could target total spending in the economy (nominal gross domestic product). If the Fed targets higher inflation, it would be less likely to brush up against the zero lower bound, where policy becomes improvisational. A nominal GDP target would balance growth and inflation. There are those in the “too hot” camp as well, arguing that the Fed is already doing too much. This camp argues that pursuing a single mandate on price stability would be preferable. Others argue that aggressive monetary policy affects “financial stability” and can cause bubbles. But if zero-lower-bound policy really rocks the financial sector by creating asset bubbles, the best bet is to get away from the zero lower bound in recessions. And rather than risk prolonged recessions to keep the banks safe, use leverage ratios and bring derivatives under insurance laws to keep the financial sector on an even keel. Mr Bernanke was reacting to the worst macroeconomic crisis in 70 years. Whoever comes next will be required to help the Fed internalise and act on what it has learnt from

192 the Great Recession. That lesson has to be that policy was too tight – and only a dramatic shift can prevent the next crisis. The writer is a fellow at the Roosevelt Institute http://www.ft.com/intl/cms/s/0/a5d610e6-f83c-11e2-b4c4- 00144feabdc0.html#axzz2aQ89PMtf

ft.com GlobalEconomy EU Economy July 29, 2013 3:03 pm ECB pressed to open up as officials back call to publish minutes By Michael Steen in Frankfurt Two senior officials at the European Central Bank have jointly called for the publication of secret minutes from the bank’s monthly interest rate-setting meetings to improve transparency. The ECB is the only major central bank that does not publish minutes of its meetings, instead keeping them locked in the archives for 30 years in a measure that was designed to allow the 23 members of its governing council to take decisions that might go against their national interests. More ON THIS TOPIC/ ECB to accept more ABS as collateral/ Global Insight Central bankers face ‘loose lips’ warning/ Talking Point Thoughts on ECB forward guidance/ Eurozone companies face debt divergence IN EU ECONOMY/ China to freeze trade probes in solar deal/ Patent cliff problem for Ireland bailout/ Eurozone divergence tough to shake off/ Greece amends law to unlock €4bn bailout Benoît Coeuré and Jörg Asmussen, a Frenchman and a German who sit on the bank’s six-person executive board, threw their weight behind the publication of minutes in a joint interview with French and German newspapers published on Monday. “There was a time when the ECB was ahead of the curve in its communications and transparency as the first central bank with regular press conferences by its president. Now the ECB is the only large central bank that does not publish its minutes of meetings,” Mr Coeuré said. “There is a demand in society for transparency and accountability. Therefore, I personally think that the ECB should start publishing its meeting minutes soon.” Mr Asmussen added that the minutes should identify how individual council members voted on given issues and outline the reasons for their vote. Under existing arrangements, Mario Draghi, president, holds a press conference after each interest rate-setting meeting during which he typically does not offer much detail other than whether a decision was agreed unanimously or not, in keeping with practises established by his predecessors at the bank.

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Asked if there was a majority on the council that would support publication of minutes, Mr Asmussen told the Süddeutsche Zeitung and Le Figaro: “Every majority starts as minority. It is an ongoing discussion in the council.” The governing council is made up of the six executive board members including Mr Draghi and the 17 national central bank governors of eurozone countries. It is the latter group most likely to face pressure if they are seen to support monetary policy decisions that might be justifiable for the bloc as a whole, but go against the narrow national interest of their home country. The eurozone’s stark economic divergences – with huge differences in unemployment rates, growth prospects and business cycles across the bloc – will only serve to exacerbate such pressures. Aside from Mr Coeuré and Mr Asmussen, Peter Praet, a Belgian executive board member, has backed the publication of minutes, saying earlier this month it would happen “sooner or later”. Erkki Liikanen, president of Finland’s central bank, also called for them to be published last September, when the opposition of Jens Weidmann, Bundesbank president, to the ECB’s bond-buying programme highlighted tensions on the council. Mr Weidmann, who has made no secret of his dissent from the majority line on the subject of bond-buying, has not explicitly backed the publication of minutes but frequently talks about the need for central bankers to take account for their actions and demonstrate their adherence to the mandates they operate under. Mr Draghi, meanwhile, has maintained that he is thinking about the question. In March 2012 he said: “you want to keep the deliberations of the governing council as separate as you can from the national identity of its members”. Last September, asked again, he said he still had an open mind and there were pros and cons to weigh up. It was important, he said, to bear in mind “the European context, which is different from that of the United States and the United Kingdom.” The Federal Open Market Committee at the Federal Reserve publishes full minutes three weeks after each meeting, followed five years later by a transcript of the meeting. The Bank of England’s Monetary Policy Committee publishes its minutes two weeks after meetings and the Bank of Japan releases minutes in the month after a meeting and a full transcript 10 years later. http://www.ft.com/intl/cms/s/0/07d112d4-f845-11e2-b4c4- 00144feabdc0.html#axzz2aQ89PMtf

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ft.com Comment Editorial July 28, 2013 4:29 pm What the Federal Reserve needs Ben Bernanke’s succession comes at a critical moment As Federal Reserve chairman Ben Bernanke’s term ticks towards its end in January, the race for his succession is intensifying. The outcome matters globally. The Fed chair is the world’s most influential central banker. Who sits in the post has rarely been more critical. The Washington chatter focuses two front runners. One is Janet Yellen, currently vice chair to Mr Bernanke. The other is Lawrence Summers, who served as Treasury Secretary under Bill Clinton and advised President Barack Obama, (and is a current Financial Times columnist). Others mentioned include some with heavy Fed experience: Roger Ferguson (now head of fund manager TIAA-CREF), Donald Kohn (member of the Bank of England’s Financial Policy Committee), and Tim Geithner (Mr Obama’s first Treasury secretary). More ON THIS STORY/ Senate letter backs Yellen for Fed role/ Dollar falls on fears of dovish Fed/ FT Alphaville Why Yellen should be the next Fed chair/ Slideshow Candidates to be the next US Fed chairman/ Edward Luce Summers has edge in race to head Fed EDITORIAL/ The west and Iran’s new broom/ An Olympic legacy/ Europe risks the ‘wrong’ kind of recovery/ Vive la déférence Before the weekend, 20 Senate Democrats signed a letter of support for Ms Yellen. Mr Summers, meanwhile, has allies behind the scenes in the White House. Mr Obama is not in a hurry to decide on Mr Bernanke’s successor; the hectic lobbying has stayed his hand. It is, however, timely to state the criteria the president should have in mind as he decides. The next chair of the Fed will take the helm from Mr Bernanke at a critical moment. While the US economy is out of the worst straits of the 2008-09 financial crash, the recovery remains too weak, and continued monetary stimulus is essential to keep it going. Even erring slightly on the side of tightening risks quick and significant harm to America’s households and businesses. Much can also go wrong on the way back to a normal monetary policy even if the Fed gets the timing of the exit right. Finally, the Dodd-Frank reforms endowed the central bank with vast new responsibilities to keep the financial system safe. Different qualities will be crucial to accomplish all these tasks. Intellectual and political flexibility will be needed for the evolving challenges of the economy as it hopefully continues to strengthen. But four characteristics are essential: First, extraordinary competence in monetary economics. The monetary conditions that prevail in the US and elsewhere today – nominal short-run interest rates approaching zero and broken monetary transmission mechanisms, yet stable prices – have few historical precursors. Neither do the policy innovations introduced by the Fed and other central banks. These tools require expert handling. Second, a supreme ability to communicate with the public and markets. Central banking is about expectations management as much as anything. The Fed has rightly

195 taken a more active approach to communication under Mr Bernanke. But the turmoil following his announcement that the Fed might slow its asset purchases shows that it can still improve the way it talks to hypersensitive markets. Third, the next chair must strike the right balance between consensus-seeking and toughness. There will always be a variance of views on the Federal Open Market Committee that sets interest rates, but the Fed will be more effective – not least in communicating its intentions – if differences are managed with a view to creating cohesion. At the same time, the chair must vigorously protect the Fed’s independence from politicians and special business interests. Fourth, the new chair must be able to fulfil the Fed’s role in making finance safer against Wall Street resistance. This demands a thorough understanding of financial markets and their institutions – including how conventional economic analysis failed to spot the noxious incentives that caused risks to build up. The Fed’s credibility has suffered from its failure to foresee the crisis. It must now show that it can excel in safeguarding financial stability in future, as it has excelled in limiting the damage from the collapse it failed to prevent. http://www.ft.com/intl/cms/s/0/132b794e-f773-11e2-a618- 00144feabdc0.html#axzz2aQ89PMtf 10:30 Thank you, we have already counted your vote. Janet Yellen 77.27% (153 votes)

Larry Summers 22.73% (45 votes)

Total Votes: 198

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July 28, 2013 Stranded by Sprawl By PAUL KRUGMAN Detroit is a symbol of the old economy’s decline. It’s not just the derelict center; the metropolitan area as a whole lost population between 2000 and 2010, the worst performance among major cities. Atlanta, by contrast, epitomizes the rise of the Sun Belt; it gained more than a million people over the same period, roughly matching the performance of Dallas and Houston without the extra boost from oil. Yet in one important respect booming Atlanta looks just like Detroit gone bust: both are places where the American dream seems to be dying, where the children of the poor have great difficulty climbing the economic ladder. In fact, upward social mobility — the extent to which children manage to achieve a higher socioeconomic status than their parents — is even lower in Atlanta than it is in Detroit. And it’s far lower in both cities than it is in, say, Boston or San Francisco, even though these cities have much slower growth than Atlanta. So what’s the matter with Atlanta? A new study suggests that the city may just be too spread out, so that job opportunities are literally out of reach for people stranded in the wrong neighborhoods. Sprawl may be killing Horatio Alger. The new study comes from the Equality of Opportunity Project, which is led by economists at Harvard and Berkeley. There have been many comparisons of social mobility across countries; all such studies find that these days America, which still thinks of itself as the land of opportunity, actually has more of an inherited class system than other advanced nations. The new project asks how social mobility varies across U.S. cities, and finds that it varies a lot. In San Francisco a child born into the bottom fifth of the income distribution has an 11 percent chance of making it into the top fifth, but in Atlanta the corresponding number is only 4 percent. When the researchers looked for factors that correlate with low or high social mobility, they found, perhaps surprisingly, little direct role for race, one obvious candidate. They did find a significant correlation with the existing level of inequality: “areas with a smaller middle class had lower rates of upward mobility.” This matches what we find in international comparisons, where relatively equal societies like Sweden have much higher mobility than highly unequal America. But they also found a significant negative correlation between residential segregation — different social classes living far apart — and the ability of the poor to rise. And in Atlanta poor and rich neighborhoods are far apart because, basically, everything is far apart; Atlanta is the Sultan of Sprawl, even more spread out than other major Sun Belt cities. This would make an effective public transportation system nearly impossible to operate even if politicians were willing to pay for it, which they aren’t. As a result, disadvantaged workers often find themselves stranded; there may be jobs available somewhere, but they literally can’t get there.

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The apparent inverse relationship between sprawl and social mobility obviously reinforces the case for “smart growth” urban strategies, which try to promote compact centers with access to public transit. But it also bears on a larger debate about what is happening to American society. I know I’m not the only person who read the Times article on the new study and immediately thought, “William Julius Wilson.” A quarter-century ago Mr. Wilson, a distinguished sociologist, famously argued that the postwar movement of employment out of city centers to the suburbs dealt African- American families, concentrated in those city centers, a heavy blow, removing economic opportunity just as the civil rights movement was finally ending explicit discrimination. And he further argued that social phenomena such as the prevalence of single mothers, often cited as causes of lagging black performance, were actually effects — that is, the family was being undermined by the absence of good jobs. These days, you hear less than you used to about alleged African-American social dysfunction, because traditional families have become much weaker among working- class whites, too. Why? Well, rising inequality and the general hollowing out of the job market are probably the main culprits. But the new research on social mobility suggests that sprawl — not just the movement of jobs out of the city, but their movement out of reach of many less-affluent residents of the suburbs, too — is also playing a role. As I said, this observation clearly reinforces the case for policies that help families function without multiple cars. But you should also see it in the larger context of a nation that has lost its way, that preaches equality of opportunity while offering less and less opportunity to those who need it most. http://www.nytimes.com/2013/07/29/opinion/krugman-stranded-by- sprawl.html?partner=rssnyt&emc=rss&_r=0

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July 29, 2013, 7:04 am 31 Comments Fear of Froth Carola Binder parses President Obama’s big interview with the Times, and thinks it hints at a Summers, or anyway non-Yellen appointment. Maybe; in any case, can I say just how really stupid it is for the White House to have allowed this show even to get started? Here we have Obama trying to reboot his economic message, and much of the reporting is instead focused on palace intrigue. Anyway, the passage in question is striking; whatever it says about the Fed succession, it does give us a sense of how the people Obama listens to talk. And it’s not good: And what I’m looking for is somebody who understands the Fed has a dual mandate, that that’s not just lip service; that it is very important to keep inflation in check, to keep our dollar sound, and to ensure stability in the markets. But the idea is not just to promote those things in the abstract. The idea is to promote those things in service of the lives of ordinary Americans getting better. And when unemployment is still too high, and long-term unemployment is still too high, and there’s still weak demand in a lot of industries, I want a Fed chairman that can step back and look at that objectively and say, let’s make sure that we’re growing the economy, but let’s also keep an eye on inflation, and if it starts heating up, if the markets start frothing up, let’s make sure that we’re not creating new bubbles. So, here we are with inflation at a long-term low, many economists arguing that we need higher inflation expectations, and unemployment the overwhelming problem we face. Yet Obama appears if anything to give more emphasis to inflation-fighting than to unemployment reduction, and throws in stuff about bubbles; basically, he has a definite tight-money lean. I don’t know who it’s coming from. And this has, by the way, been true all along. Back in the fall of 2009 the word I got was that senior Administration officials believed that we were in a Treasury bubble,and that long-term interest rates — then around 3.5 percent — might soar any day now. This in turn was partly behind the disastrous “pivot” away from unemployment to deficits. The bad news from that Times interview is that it suggests that the president is still listening to the people who were telling him, four years ago, to be afraid of surging rates unless we turned to fiscal austerity. Not good. http://krugman.blogs.nytimes.com/2013/07/29/fear-of-froth/ Milton’s Paradise, Still Lost Robert Skidelsky has an interesting note asking why quantitative easing has received so much stress in recent economic debates. Its effectiveness is, after all, questionable — whereas there is overwhelming evidence that fiscal policy works as advertised.

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Skidelsky is right, I think, to downplay the idea that it’s all welfare for the financial service sector. After all, many of the most bitter critics of QE come from Wall Street. He argues that the affection for QE comes, instead, from the alluring prospect — to some conservatives, at least — of getting economic stabilization without any need for activist government outside the narrow sphere of monetary policy. What he doesn’t say clearly, at least in this piece, is that this was the allure of old-fashioned monetarism too. Just stabilize the money supply, declared Milton Friedman, and we don’t need any of this Keynesian stuff (even though Friedman, when pressured into providing an underlying framework, basically acknowledged that he believed in IS-LM). Why, if only the Fed had stabilized M2, there would have been no Great Depression! Friedman’s money supply rule soon proved itself inadequate, but a more flexible kind of monetarism — one that still left no role for fiscal policy — did end up ruling conventional wisdom from the mid-80s to 2007, the era of the Great Moderation. Then came the Great Recession, the Fed funds rate came up against the zero lower bound, and we were banished from the monetarist paradise. In fact, as I’ve written on a number of occasions, recent experience pretty conclusively shows that Friedman’s claims about how easy it would have been to avert depression were all wrong. Still, QE, in the eyes of its most enthusiastic advocates, can return us to Milton’s Eden. And they are determined to read the evidence as confirming that hopeful notion. Yet there are many economists, myself included, who regard this view as highly unrealistic, yet support more aggressive Fed action all the same. Why? First, because it might help and is unlikely to do harm. Second, because the alternative — fiscal policy — may be of proven effectiveness, but is also completely blocked by politics. So the Fed’s efforts are all we have. http://krugman.blogs.nytimes.com/2013/07/27/miltons-paradise-still-lost/

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ft.com World Europe

GLOBAL INSIGHT Last updated: July 28, 2013 12:51 pm Policy paralysis in Europe could extend far past German election By Quentin Peel in Berlin It may take pressure from the markets to trigger EU reform

©AFP Outside Germany, everyone seems to be waiting with bated breath for the outcome of the German general election. In Brussels and Paris, London and Washington, the general view is that nothing can be decided before September 22, for fear of upsetting the re-election plans of Angela Merkel, the German chancellor. More ON THIS TOPIC/ Markets Insight Cross-border equity ownership is key to eurozone risk-sharing/ Martin Sandbu Europe should let go of hopeless causes/ Editorial Europe risks the ‘wrong’ kind of recovery/ Eurozone divergence tough to shake off GLOBAL INSIGHT/ ‘People’s Pope’ connects with Brazil poor/ Insults and division as India’s election phoney war gathers pace/ Low inflation worries central bankers/ German finance minister’s vision at risk Controversial issues such as progress towards a eurozone banking union with a common resolution authority are being put on hold. So too is any hint of redrafting the Greek bailout programme to provide more debt relief, or indeed anything that might have to be financed by German taxpayers. That certainly suits Ms Merkel, whose instinct is to neutralise any points of potential controversy, so that her personal popularity will sweep her centre-right coalition back to power. Despite her lead in the polls, the outcome is still finely balanced, though the chances of an outright opposition victory look ever less likely. Look at the European scenario for a moment from the other end of the telescope. The view from Berlin is that everyone else is hesitating to move until they know who is going to win the election. That is especially true in France, Germany’s closest European partner, whose support is seen as essential in Berlin for any future initiative. François Hollande, France’s socialist president, appears to be gambling on his allies in the German Social Democratic party (SPD) joining Ms Merkel’s Christian Democrats

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(CDU) in a “grand coalition” government. That might give him more backing for a pro- growth agenda in the eurozone. A year ago, a grand coalition in Berlin looked the most likely outcome. But the SPD is flatlining in the polls, while Ms Merkel’s preferred partners – the liberal Free Democrats, with whom she is currently in coalition – have picked up just enough to get back into the Bundestag. For the first time, it looks as if the present regime might continue. A grand coalition is also not necessarily a recipe for stable government, even though 52 per cent of German voters favour that outcome. It will be hugely unpopular within the SPD, whose members might insist on a party-wide vote before participating. Last time they served under Ms Merkel – from 2005-2009 – they were rewarded with their worst election result since the second world war. Would a grand coalition change German policy in the eurozone? Not a lot. SPD policy makers say they would be “more Keynesian”. They would no doubt fight to take over the finance ministry from Wolfgang Schäuble as the price of their participation in power. But they would share his hostility to any banking resolution scheme financed by domestic taxpayers – without a German veto. They want it financed by the banks themselves. The priority for SPD voters is to spend their money on relieving social pressures, and investing in infrastructure, at home. There will be no deficit spending. The party favours a jointly guaranteed debt redemption scheme for the eurozone, but it has gone very cool on the idea of eurozone bonds. The truth is that unless there is a big policy shift, then whoever wins in Berlin there will be no rush to reform in the rest of the eurozone, especially if that means treaty change. And Berlin won’t move on anything as controversial as a common bank resolution fund, or eurozone bonds, without treaty change. European elections in 2014, plus municipal elections in France, the appointment of a new European Commission and then British elections in 2015, all point to prolonged postponement of any serious change in the governance of the eurozone or the European Union. There will be a one-year respite in 2016, before a potential “perfect storm” in the electoral cycle in 2017, with both France and Germany back at the polls – and the UK possibly holding a referendum on EU membership. So 2016 will be the one time when a treaty change might be contemplated. Yet the markets may not wait for such an extended electoral cycle. If they are seized by a new bout of nervousness – especially if it affects a bigger economy, such as Spain, Italy or France – then the whole agenda would have to be accelerated. Ms Merkel, assuming she is re-elected, may then be more ready to move than Mr Hollande. http://www.ft.com/intl/cms/s/0/54d018da-f60d-11e2-a55d- 00144feabdc0.html#axzz2aMUbzLcH

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Daily Morning Newsbriefing July 29, 2013 The PD on the verge of imploding The PD is in turmoil over the election of the next party general secretary, due to be held at its general congress before the end of November, as La Stampa reports. The key issue is the future role of party’s leader. According to Enrico Letta, the new PD leader should focus on the party and automatically not be its premier candidate the next time there are elections, as Matteo Renzi wants it. The mayor of Florence is considering running for general secretary, but wants this position to come with the status of candidate for the job of PM. As La Repubblica reports, Renzi is trying to renew the current rules to gain more power and to have the freedom to lead the party at next political elections. Renzi wants PD primaries open to every Italian, while the old guard wants a vote closed only to centre-left electors. Just one months ago the party’s secretary Guglielmo Epifani has guaranteed that the primaries will be open, but now the opinion among the old guard is going the other way. As La Stampa’s Marcello Sorgi reminds, the PD is imploding over the primaries. No party would ever dream of imposing these restrictions because they would jeopardize the success of the election, Sorgi writes. In majority systems, elections are won by capturing the votes of independents leaning to the centre and this is what the PD should do to reinforce its position and the country, he writes. However, there could be a solution, Stefano Folli writes on Il Sole 24 Ore. Right now, Renzi is losing the political fight against the old guard of PD, due to the immobility of Epifani. The PD is a tired formation, of uncertain identity and indecipherable perspective, Folli writes. The solution could be a ticket Letta-Renzi, with the first one as party’s secretary and the second one as running candidate for premiership. Unfortunately, as Folli argues, this is impossible due the lack of foresight of the PD’s ruling elite, which could led the party to a self-destruction. Italy prepares for Berlusconi verdict Silvio Berlusconi will tomorrow face the last appeal at Supreme’s Court that could confirm the one-year prison sentence and a five-year ban from public office. In an interview to the main centre-right newspaper Libero, Berlusconi is quoted as saying that he will go to prison if the Court will sentence against him. In that case, the fragile coalition supporting Enrico Letta may implode, Il Corriere della Sera writes. This is, however, not the most likely scenario for Eugenio Scalfari. In his editorial in La Repubblica, Scalfari argues that the Berlusconi’s trial won’t have an impact on Italian politics because any derailment could have unexpected effects. The stakes are simply too high. Both the PD and PdL know that a failure of the Letta government could be the beginning of the end for the country. Italy plans to abolish provincial governments in 2014 Italy will abolish Provinces before provincial elections in 2014, saving over €1bn in public expenditures. As La Repubblica reports, the government wants to prevent the renewal of provincial administrations next year. Last Friday the Letta’s cabinet

203 approved a bill that will strip many of the powers of Italy’s provincial governments ahead of plans to abolish them completely in Constitutional reforms. However, the passed bill introduces a new kind of local government. It will reorganize Italian town and city councils, merging many and creating metropolitan authorities for big cities and their surrounding areas. According to La Repubblica, the new measure will cost at least €500m in the first year, reducing the savings from the abolition of Provinces. Daveri on Italy’s export-led recovery Francesco Daveri makes the daring forecast on Lavoce.info that Italy will experience an economic recovery as early as this autumn. The signals coming from the industrial sector, according to the calculations of Lavoce, are positive but the recovery will be very different from the latest. It will be driven only by exports, Daveri writes. Import demand will be down 35% from the level reached in 2007 and down by 15% from 2011. By contrast, exports will be pushed up due to demand from the BRICs and emerging markets. The results could be dramatic. The Italian SMEs have a low level of internationalisation - only 25% of SMEs have foreign sales, according to ISTAT - and they will continue to suffer from the ongoing fall of internal demand and consumption. The Italian government should thus cut business taxes and begin paying state debt to private firms to alleviate the problems. Spain writes off €26bn Generalised weeping and gnashing of teeth in Spain as the 2012 accounts of the Orderly Bank Restructuring Fund FROB show the government expects to lose half of the moneys injected into the banking system last year. El País writes that the €52bn injected in 2012 into the nationalised Bankia, Novagalicia, Catalunya Banc, Banko de Valencia, and also Caja España Ceiss and BMN, correspond roughly to the amount cut from the health and education budgets in the same year. According to the paper, in its 2012 accounts the FROB has carried out an economic value estimate of its stakes in the nationalised institutions and booked a loss of €26bn on its holdings. Together with the FROB's losses of nearly €11bn in 2011 and €314m in 2010, the total accumulated losses on the banking rescue are almost €37bn. El País quotes estimates from Spain's Banking Association AEB that there are an additional €33bn in state guarantees which depend on the evolution of nonperforming loans in the nationalised institutions. Business survey shows loss of confidence in Rajoy El País reports that Deloitte's "Business Barometer" survey of Spain's firms shows that support for Mariano Rajoy's policies has deteriorated badly since his government was formed at the end of 2011. Where over 50% of businesses had a favourable opinion of Rajoy's team at the start of their mandate, only 15% now think the government's performance has been "good or very good". 85% of those polled consider Rajoy's reforms "insufficient" and even his labour market liberalization has seen its support drop from nearly 47% a year ago to under 40%. The most unpopular policies are R&D (2/3 against) and fiscal policy (4/5 against). Comparing Rajoy's numbers to those of his predecessor Zapatero, El País notes that Zapatero's support dropped to 6% at the end of a long tenure, while Rajoy's has gone down from 50% to 15% in less than two years. A quarter of respondents (269 firms of 2,400 polled) admit difficulties accessing credit, while an additional 11% decline to state.

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Spain introduces third cash-for-clunkers programme The Spanish government will launch a third round of its PIVE cash-for-clunkers programme, aimed at supporting the sagging market for new cars while replacing cars older than 10 years and commercial vehicles older than 7 years. RTVE writes that the government has allocated €70bn until the end of the year for the purchase of up to 70k new vehicles. The €1,000 government incentive must be matched by a manufacturer rebate, for a total discount of €2,000. The just-ended PIVE 2 resulted in 153k car purchases until the end of July using up nearly 100% of the allotted money. By contrast, the first PIVE program in the autumn of 2012 had some money left over. Cyrus bail-in and Russian oligarchs Dow Jones writes that the irony of Cyprus bail-in is that its banks could end up to be owned by those Russian oligarchs, Eurozone policy makers refused to bailout. About half of the deposits of the largest lender Bank of Cyprus is in non-EU hands. The bail-in plan, will take away part of these deposits and give their owners equity in the new, healthier and leaner bank. A significant share of the bank thus looks likely to end up in Russian hands, exactly those oligarchs suspected of money laundering and other questionable business, so the article. Tsipras and the FAZ Alexis Tsipras threw out a FAZ journalist after being questioned about German bashing and his party’s flirt with the “Independent Greeks”. The unabridged version of the interview behind this éclat was printed in the FAZ, and the Greek interpretation of the events can be read in Avgi. The FAZ quoted from a speech given by Tsipras in June last year where he said that the Greek government would hand over the Greek flag to Angela Merkel – an utterance Tsipras denied making. Reading through the transcript it looks like a silly parody, a clash of two stereo-type reactions: The German journalist cornered an angered Greek and triggered an emotional reaction, a classical tale of how to corner someone, except that this someone was Alexis Tsipras. In the second act Tsipras press speaker accused the journalist of overstepping the journalistic ethics relying on rumours and non-verified facts, while the FAZ journalist carefully detailed all his sources in the transcript, including Tsiparas own speeches. What’s the next act of this summer drama going to be? Self-stylised drama like this either end up with some face-saving exercise or they linger on forever, delivering new munition for further prejudice. Portugal plans corporate tax cuts to 19% by 2018 Portugal's government announced cuts in corporate taxes from early 2014 to 19% by 2018, according to Dow Jones. The current rate is 25% plus additional local and state taxes, which adds up to a rate of 31.5% for Portuguese companies, one of the highest corporate tax rates in Europe The finance ministry said 19% would be comparable with rates in Poland and in the Czech Republic, "two countries with which Portugal competes to attract investment". The government said the reform, set be carried out over five years, will also widen the tax base and phase out exemptions as well as local surcharges, Reuters reports.. Irish central bank cuts down growth forecast for this year Ireland's central bank cut its growth forecasts for Ireland to 0.7% in 2013, down from 1.2%, citing sluggish exports and a deeper contraction in consumer spending, Reuters reports. The central bank said exports would grow by 1% this year, less than an earlier

205 forecast of 2.5%, while personal consumption would contract by 0.5%. Weak consumption and exports "are likely to constrain the pace of recovery in the economy for the remainder of the year," the central bank said in its quarterly economic report. The government is still on target to meet its 7.5% deficit target for the year, but should resist the temptation to ease back on its fiscal adjustment plans, the report said. More needed to be achieved on addressing mortgage arrears, saying realism and an "openness to innovative approaches" was needed from all sides. Coeure and Asmussen want ECB to publish minutes This is from a joint interview in Suddeutsche Zeitung with Benoit Coure and Jorg Asmussen, who both support the idea of a formal publication of minutes – a subject heavily discussed when the ECB was first set up, but rejected by the central bankers themselves on grounds that it would make them subject to political pressure at home. Coeure said the ECB is now the only large central bank that does not publish its minutes. He said society demands openness, which is why he personally favours the publication of minutes. Asmussen said the minutes should include voting records of all the members of the governing council, including the reasonings. Asked whether this is realistic, Asmussen said the council was discussing the issue at present. “Each majority starts as a minority,” he said. War of the petitions Frankfurter Allgemeine has the story of an appeal launched by five economists – Beatrice Mauro di Weder, Marcel Fratzscher, Charles Wyplosz, Francesco Giavazzi and Richard Portes – who expressed deep concern about the attacks by economists, politicians, and ECB watchers against the OMT. One of the authors confirmed that the appeal had 100 signatures from other economists. FAZ has sampled a few German economists who criticised the appeal, including Jurgen von Hagen, who called it “extremely dreadful” as it constitutes an attempt to influence Germany’s constitutional court. He asked rhetorically whether the authors want the court to be subject to a majority view by economists? Fritzscher told FAZ that the main idea behind the petition was not to exercise pressure on the court, but he said nevertheless that he was concerned by comments from some of the justices during the recent hearings, which suggested an anti-OMT bias. The petition said the OMT was one of the most successful communication exercises for decades because it stopped a bank run. It thus deserves to be supported. If the court tried to restrict the ECB in its exercise of the OMT programme, this would bring great danger. One German economist, who has been interviewed, said he is concerned that the petition would create the impression that the mainstream of German economists stands against the rest of the world. Of course, the mainstream of German economists is pretty much isolated in the global context. Their frame of reference is uniquely national, and they do not even pretend to seek a solution for the eurozone’s successful survival. The German establishment is clinging to the legal and constitutional safeguards of a treaty, which explicitly excludes monetary financing of budget deficits. Yet, while we support the overall drift of the petition, we are not so certain whether Mario Draghi's “whatever it takes” will go down in the history of central banking as one of the great game-changing central bank communication events. We see this similar to the way Zhou Enlai assessed the impact of the French revolution as “too early to tell”. In terms of the petition's effect in Germany, we fear that it may ultimately push Germany’s beleaguered economists and constitutional justices deeper into the bunker.

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Peel on paralysis Writing in the FT, Quentin Peel tries to debunk the popular notion that once the German elections are over, the world will be a different place, as the campaign has put eurozone crisis resolution on effective hold. For once, the present coalition may get back in. But even if a Grand Coalition were the outcome of the elections, it would not change Germany’s eurozone policies by much. The SPD would take over the finance ministry, but they would also be opposed to a bank resolution proposal financed by German taxpayers. Peel’s overall assessment is: “Berlin won’t move on anything as controversial as a common bank resolution fund, or eurozone bonds, without treaty change.” He said the political timetable – European elections in 2014, municipal election in France, the new European Commision, UK elections in 2015 all points to postponement of treaty change. We totally agree with Peel that the German elections will produce very little change to the reality of eurozone crisis management, almost no matter what the result will be. Our expectation is that the elections will end up with a Merkel-led government, either a continuation of the existing coalition, or a grand coalition. The latter would have some impact on overall macro policies, and bank regulation, but would provide no relief to the eurozone periphery directly. At this point, the European elections in 2014 look to be the more interesting ones to watch out for. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.611 0.614 0.619 Italy 2.724 2.740 2.750 Spain 2.919 2.924 2.924 Portugal 4.814 4.803 4.811 Greece 8.585 8.467 8.49 Ireland 2.206 2.222 2.229 Belgium 0.889 0.903 0.910 Bund Yield 1.676 1.664 1.654

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.326 1.3271

Yen 130.700 129.82

Pound 0.862 0.8627

Swiss Franc 1.232 1.2329

ZC Inflation Swaps

previous last close

1 yr 1.5 1.5

2 yr 1.45 1.45

5 yr 1.59 1.6

207

10 yr 1.94 1.94

Euribor-OIS Spread

previous last close

1 Week -6.014 -6.014

1 Month -2.957 -3.057

3 Months 3.786 2.986

1 Year 31.071 30.871

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-07- 29.html?cHash=9d6833d078da41ff1aab6e0eb61cee91

ft.com Comment Opinion

July 28, 2013 4:02 pm Europe ought to let its hopeless causes go bankrupt By Martin Sandbu The cure for the crisis is a dose of American-style tough love, writes Martin Sandbu

©James P. Morse The bankruptcy of the once great city of Detroit comes just a few years after that of General Motors, Motown’s legendary car manufacturer. Both collapses crystallise decades of accumulated failures, including a failure to look reality in the eye sooner. They also symbolise the US’s big advantage over Europe: its greater willingness to let go of hopeless causes so that more successful activities have room to grow. The ability to let doomed ventures die is a sign of strength, not weakness. If Europe – especially the eurozone – wants out of the crisis, it should adopt American-style tough love. More ON THIS STORY/ Global Insight Paralysis may extend past German election/ Eurozone edges back into growth in July/ IMF warns ECB may have to cut interest rates/ In depth Eurozone in crisis/ In depth Britain in Europe ON THIS TOPIC/ Markets Insight Cross-border equity ownership is key to eurozone risk-sharing/ Editorial Europe risks the ‘wrong’ kind of recovery/ Eurozone divergence tough to shake off/ Markets Insight Lower fertility rates threaten tax base

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IN OPINION/ Anatol Lieven Criticise Putin but don’t back his rivals/ Stian Westlake New lenders deserve Church’s blessing/ Michael Pettis China will slow down but it can handle it/ Cameron’s critics have much venom but little sense of history It is natural to be rattled when giants buckle. The liabilities restructured by GM amounted to $172bn. Its host city faces debts of possibly $20bn, according to Detroit’s emergency manager Kevyn Orr. Much of this represents losses borne by people who were sure their claims would be honoured. That is no doubt unfair; and one cannot fault burned creditors for doing what they can to get others to make them whole, as Detroit unions now want the federal government to do. By and large, however, the US is prepared to let the chips fall where they may; more so, anyway, than Europe. It was not always so – president Gerald Ford’s infamous “drop dead” to New York City (which he never really said) in 1975 ended with rescue loans anyway. But in the past few years, the US has pointed banks (Lehman Brothers and many smaller ones), other systemic corporations (the car industry) and many municipal governments to the nearest bankruptcy court. America matches this toughness with love. In the US, taking a risk and failing is not the end: there is honour in getting back up. Bankruptcy offers a new chance, and the culturally favoured response is to keep fighting. American economic dynamism owes much to this forgiving attitude to risk-taking. Europeans regard insolvency with a much darker moral taint. To go bankrupt has traditionally been to be branded untrustworthy – a shame to hide by leaving business for ever, even (once upon a time) by taking leave of one’s life. This still shows up in such archaic rules as Ireland’s 12-year bankruptcy period (which is finally being reformed). Paradoxically, this cultural allergy to failure leads not just to less risk-taking, but to policies that bail out those that do take big risks and lose. Europe finds the idea of default so intolerable that, in the current crisis, it has preferred to cover the debts of the bankrupt. It suffers as a result. This was clear in the case of Greece. Creditor states insisted that a bailout was unacceptable. But the thought that a sovereign European state might not pay its debts proved more unacceptable still. So loans from the eurozone – and an International Monetary Fund bullied into participating – were spent to postpone the reckoning. The same has happened with banks. In 2010, the Irish government did all it could to fill the holes in its banks’ balance sheets with taxpayer money rather than declare them insolvent, protect retail depositors and let creditors pick up the pieces. When Dublin realised it did not have enough taxpayer funds to do the job, its eurozone partners strong-armed it into borrowing from them to keep the bailout going. The aversion to bankruptcy disfigured policy towards banks in Spain and elsewhere, too. Reality has forced Europeans to change their minds, as it usually does in the end. Greece’s sovereign debt was eventually restructured – but not before much of the benefit of restructuring had been lost, and not without the pretence that it was voluntary for bondholders. In Cyprus, although the amounts were small, the prospect of bailing out Russian depositors was too much to stomach for northern Europe. Even these lessons are taking time to sink in. The US gave itself the power to wind down big banks, and impose losses on their creditors, in 2010. Most EU governments have still not got around to passing this crucial legislation. It will be years before they

209 are forced to do so by Brussels, even though the need for a “bail-in” is agreed in principle. How much the eurozone could have saved itself by embracing debt restructuring as a pragmatic policy from the start of the crisis is unknown. But years of missing growth – relative to the US’s modest but decent trot out of the crisis – is partly due to Europe’s remaining debt overhang. As debt balances in the US economy have come down steeply, people are spending again. Europe is held back by banks wobbling on top of capital cushions that are all too thin – the result of a refusal to convert debt into equity when other sources of capital dry up. Europe can retort that the worst bankruptcy of them all – Lehman’s – showed the damage wrought by US willingness to let go. A fair point. But Americans and Europeans drew different lessons from this, too. The US has worked to end “too big to fail” (but still has a way to go). Until Cyprus, Europe did the opposite, treating even the smallest banks as if their bankruptcy would be as devastating as that of Lehman. F Scott Fitzgerald wrote: “I once thought that there were no second acts in American lives, but there was certainly to be a second act to New York’s boom days.” Fitzgerald had in mind the 1929 crash that silenced the roaring Twenties. Europe must learn from the lesson America has shown many times: allow the second act to take place, and a third can follow in due course, as it did for GM, and as it surely will for Detroit. http://www.ft.com/intl/cms/s/0/2493b90c-f51c-11e2-94e9- 00144feabdc0.html#axzz2aQ89PMtf

210 vox Research-based policy analysis and commentary from leading economists Moving towards a single contract? Pros, cons and mixed feelings Nicolas Lepage-Saucier, Juliette Schleich, Étienne Wasmer, 29 July 2013 In hard times, firms tend to offer precarious temporary contracts rather than safer, long-term contracts. In light of this, this column looks at reforming employment protection. Overall, the debate amongst economists focuses far too much on the convergence of these two types of contracts. Policymakers would do well to begin looking at other, more attractive and more implementable options. Dualism – the division of the labour market between highly paid primary workers in stable jobs and secondary workers in low paying precarious positions – has remained at the forefront of public debates in Europe, where it is pervasive. Between 1985 and 2008, European countries (with the exception of Denmark) experienced an increase in the share of temporary contracts (12% on average in OECD countries): it was particularly high in Spain (24.9% in 2010, from Eurostat) and in the Netherlands (18.5% in 2010, from Eurostat). This led to several labour-market reforms in the 1980s and 1990s. France, Germany and Spain focused their efforts on limiting the use of fixed-term contracts whereas the UK, Italy, Denmark and Finland moved towards more flexible employment protection regulations. The main culprit for dualism is employment protection, which limits employers in their termination decisions: faced with a change in the economic trend, they are likely to bear important costs if they decide to fire workers. This creates an incentive for employers to offer temporary contracts instead. More recently (since 2005), several new experiments inspired by the logic of a single employment contract have been conducted with the explicit goal of addressing the negative consequences of dualism. These reforms however had mixed political success.1 Single employment contracts Generally speaking there are two forms of single employment contracts: contracts with Progressive Seniority Rights and contracts with Long Probationary Periods. Any combination of these two forms is possible. An important question is whether the political costs of a single contract would dominate over the benefits of such a reform. New research on reforming employment protection In recent research, we argue here that the single contract would not eliminate the consequences of dualism and could increase unemployment if not accompanied with a drastic reform of employment protection (Lepage-Saucier, Schleich and Wasmer 2013). Therefore we believe that the debates focused on the implementation of a single employment contract deviate from the real issue: the reform of employment protection. The single employment contract is presented as a tool to reduce inequalities caused by dualism. Indeed, having two distinct forms of employment makes duality visible in the labour market. It also gives employers landlords or banks legal means to discriminate between different groups of workers. While temporary workers face job insecurity,

211 workers under permanent contracts are highly protected in case of dismissals and therefore are more likely to have stable careers. Access to credit and training

Cahuc and Kramarz (2004) argue that at the age of 30, permanent workers are 10 to 15 percentage points more likely to become home-owners because they benefit from an easier access to credit. Banks are less willing to grant loans to temporary workers, viewed as economically unstable. This makes it more difficult for them to buy a house. Introducing a single employment contract with a long probationary period, in this context, is likely to be inefficient: workers under probation or facing low seniority rights would still be discriminated against and the gap between workers would remain. Moreover, alternative reforms such as a partial deregulation of the rental housing market may be more effective. Another consequence of the gap between temporary and permanent workers is the inequality in the access to training. Firms invest in training if it provides workers with skills that are profitable: as a consequence, permanent workers are more likely to receive training than others. Yet again, workers under probation or with low seniority rights are likely to face an unequal access to training. However, more efficient solutions to avoid this unequal treatment exist: for instance, Lemoine and Wasmer (2010) proposed to introduce specific Pigouvian incentives for French firms by reducing their taxes or layoffs costs should they train more workers. The goal is to internalise the positive externality created by general training, using a similar logic to Blanchard and Tirole’s experience rating system. Stigma effects for laid-off workers under a single contract Temporary contracts may stigmatise workers. Indeed, due to the difficulty employers find when trying to dismiss their workers under a regular contract, employers use temporary employment as a screening device. Workers whose contracts have not been renewed are not necessarily presumed to be less motivated or less skilful: a bad economic situation could have reduced the incentive of offering regular contracts. The termination of a worker under a Contract with Progressive Seniority Rights or with Long Probationary Periods would however reinforce the negative signal on the worker since it could only be due to the workers’ lack of skill or motivation, not to the firms’ characteristics or to the formal impossibility to renew the contract. A single contract with a long probationary period may also reinforce abuse: probationary periods, which are less regulated than the current temporary contracts, could be used in the same way while protecting the workers less, since, in most countries, terminating a temporary contract is prohibited. A single contract may reduce the volatility of employment The cost difference in terms of dismissal requirements between temporary and permanent contracts leads firms to use temporary contracts as an adjustment variable to the economic conjuncture: in periods of economic booms, the high costs linked to permanent contracts lead firms to use temporary contracts (subject to weak regulations) when they seek to hire new employees. In periods of crises, the existing regulations force firms to respond to economic fluctuations through labour turnover instead of using alternative methods such as changing the workplace organisation. This results in excessive turnover in the labour market (more hires in temporary contracts but also more terminations).

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To confirm this intuition, we built a model with heterogeneous anticipations on workers’ productivity and two possible types of contracts (temporary contracts are used to screen for more productive workers). Our results show that uncertainty on productivity is a key element in the decision to hire more temporary contracts. However, simply eliminating temporary contracts reduces employment Our model also shows that without a drastic reform of employment protection, eliminating temporary contracts reduces employment: heterogeneity in the labour market discourages firms from taking risks with workers that are perceived as having a lower productivity. The analysis summarised in Figure 1 gives the following conclusions: • For a constant level of employment protection of regular contracts, removing temporary contracts leads to a drop in employment that may be as high as seven percentage points. • Reducing employment protection raises employment; this improvement is more important in the absence of temporary contracts. • Without temporary contracts, the level of employment reached when both permanent and temporary contracts coexist can only be restored if the layoffs costs of permanent contracts are drastically reduced, namely to a third of their initial value. Figure 1. the effect of employment protection (F, as a fraction of yearly productivity) on employment in a dual economy and in an economy with only regular contracts.

The problem arises not from dualism as such but rather from the costs of employment termination. Beyond these aspects, in many countries the legal prerequisites behind ‘economic layoffs’ create uncertainty. Paradoxically, countries in which they are the strongest are also those where employees perceive their job to be the less secure and suffer the most from stress. Economic layoffs may lead firms to put more pressure on their workers to increase productivity or to obtain dismissals at lower costs. Finally, employment protection is also known to have negative effects on the allocation of productive units: it can favour less productive structures and slow the allocation

213 process of workers on the most productive activities, creating distortion of capital accumulation. Conclusion A large part of the debate on how to favour employment and reduce dualism focuses on the implementation of a single employment contract. It is a way of arguing for the convergence of different types of labour contracts which, at first hand, seems like the least costly solution. However, advocates for the single labour contract have conflicting views and disagree on its characteristics. The 'single labour contract' is meant to be a quid pro quo (an exchange of something against something else, understood by all parties). By single labour contract, proponents of this measure probably mean ambitious reform of permanent contracts through a reduction of employment protection. This part may however be a qui pro quo (a misunderstanding due to voluntary ambiguity on the concepts) if it results in the disappearance of temporary contracts and the implementation of an extended probationary period. Moreover, Unions are unlikely to favour this solution since fixed term contracts are fairly well protected and could only be replaced by options which offer less security to the workers, such as longer probationary periods, or an increase of individual layoffs for insufficient skills even for permanent contracts. The focus on the convergence of contracts undermines alternative and more transparent reforms of the labour market such as the so-called ‘flexi-security model’ which argues for a to a reduction in layoff costs in exchange for a more generous unemployment insurance and more efficient active labour market policies including training reforms. Editor’s note: This column is the summary of an extended analysis: Moving towards a single contract? Pros, cons and mixed feelings, OECD Economics Department Working Paper 1026, Feb. 2013, by the three authors, and of LIEPP policy brief No. 8. References Blanchard, O and J Tirole (2003), "Protection de l’emploi et procédures de licenciement", Conseil d’Analyse Economique et La Documentation Française, October. Cahuc, P and F Kramarz (2004), "De la Précarité à la Mobilité : vers une Sécurité Sociale Professionnelle", Rapport au Ministre de l’Economie, des Finances et de l’Industrie et au Ministre de l’Emploi, du Travail et de la Cohésion Sociale. Lemoine, M et E Wasmer (2010), "Rapport no 90 du Conseil d’Analyse Economique avec Mathilde Lemoine. Les mobilités des salariés", Conseil d’Analyse Economique et La Documentation Française, May. Lepage-Saucier N, J Schleich and E Wasmer (2013), “Pros, cons and mixed feelings”, OECD Economics Department Working Paper 1026, February.

1 Recent reforms include the 2005 “Contrat Nouvelle Embauche” in France, abandoned due to legal imperatives (it was contrary to International Employment Convention n°158); the 2012 Italian reform, meant to simplify its labour code by reducing the number of contract types, but whose ambitions were substantially reduced after debates in Parliament; and the introduction of a new open-ended contract for small companies introduced in 2012 in Spain. http://www.voxeu.org/article/moving-towards-single-contract-pros-cons-and-mixed- feelings

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Friday, July 26, 2013 Great Graphic: Manufacturing PMI in US, EMU and China Marc Chandler · July 26th, 2013

Recent data suggests some moderation in the world's two biggest economies, the US and China, and some improvement in the weak sister of the major economies, the euro area. This Great Graphic that was posted on Business Insider captures this. At the same time, it is important to recognize that cross-country comparisons are misleading. For example, China's flash PMI reading shows it the weakest of the three depicted in the graph, but China's overall growth is still faster than the US and the euro area put together. Arguably it is best to evaluate each in the context of their own recent performance. The take away from the US is one of overall stability. It may not be very inspiring, but it is stable. China, by contrast, is soft and weakening. The soft landing of 2011-2012 has given way new weakness, which, at least up until now, has the approval of the new Chinese government. The euro zone's recovery is the most impressive, though overall growth is challenging and Q2 may have been the seventh consecutive quarterly contraction. Still, the ECB's anticipation of a stronger second half seems valid. This would suggest new monetary stimulus is unlikely, but the central bank is likely to remain concerned about the continued contraction in private sector lending and the gradual decline in the excess liquidity (due to the repayment of LTRO borrowings) that had been consistent with the near zero Euronia rates. http://www.marctomarket.com/2013/07/great-graphic-manufacturing-pmi-in-us.html

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Daily Morning Newsbriefing July 26, 2013 Schauble’s master plan to sabotage bank resolution Die Welt landed quite a scoop this morning with a report that Wolfgang Schauble is getting concerned about Germany’s ability to get together a blocking minority against the resolution authority proposals by Michel Barnier. As a result he is considering a legal challenge in the European Court of Justice. Germany is hell-bent to stop Barnier – one way, or the other – Die Welt reports. On the blocking minority, Germany is still hopeful to block the resolution authority with the help of the UK, Finland and Estonia, but cannot be certain after France decided to support Barnier. The paper quotes unnamed government officials as saying that the decision of whether or not to support legal action would depend on how the negotiations go. On the basis of the way things were going at the moment, the paper quotes an official as saying, things were increasingly looking that way. Germany is also ready to use what the paper called “tricks”. Germany would also consider to procrastinate the debate until there is a new Commission – one that will be more sympathetic to the concerns of Germany. The paper said the dispute concerns two aspects – who has the final says on bank closures? And who has to pay for it? Germany wants both to be national. It is rare for a European government to explain its position with such clarity. Germany clearly does not want a banking union. Germany has already been procrastinating with the endless talk about treaty change. We have always said that banking union, if done properly, is a very big deal, a much more ambitious project than a limited eurobond, because it contains an open-ended fiscal guarantee, and a deep incision in national sovereignty. The banking union that will ultimately be agreed will have neither, and is thus economically irrelevant. All banking risks will remain national. The SSM will result in an improved quality in supervision for the largest banks, but a system where every government is financially responsible for their own banking system will not solve the core problem of the crisis. It is also indicative that Germany is seeking an alliance with the UK to block this proposal, which has the overwhelming support of the other eurozone member states. What may change the German position, however, is a Grand Coalition, as the SPD is more open minded on the subject whilst in opposition, though we are not sure what it will do when in government. Credit Crunch gets worse Reuters reports that loans to the euro zone's private sector shrank by more than expected in June, down 1.6% on June 2012, according to ECB data. The trend was also negative mom. Banks granted non-financial firms €12bn less in loans in June than in the previous month, according to data adjusted for sales and securitisations, after a fall of €18bn in May. M3 grew at an annual pace of 2.3% in June, after 2.9%. The article said that weak bank lending data acted as the main constraint on the economic recovery. Analysts are

216 quoted as saying that the extraordinary weakness of the credit side may induce the ECB to make another rate cut, despite the recent signs that the economy was turning. In a separate report, Reuters writes that three Spanish banks, including Bankia, reported rising bad debts – as a direct consequence of the recession. Bankia, Bankinter and Sabadell all increased earnings due to lower write-down on properties, but the recession is now weighing in heavily on the banks. IMF sceptical on recovery The IMF expressed scepticism about the economic recovery, saying the eurozone remains weighed down by the financial crisis, and the weakness in the financial sector. In its annual Article IV report, the IMF said the recovery remained elusive, as financial markets remain fragmented along national lines, and as banks hold back the flow of credit. The forecast is for a 0.6% contraction of GDP this year, to be followed by a weak 0.9% expansion in 2014. The IMF says inflation is going to be very low, with some deflationary risks. The reports calls on the ECB to ease monetary policy further, including through rate cuts if conditions deteriorated substantially. Here is an abridged version of the IMF’s forecasts for the main indicators: 2010 2011 2012 2013 2014 2015 Real GDP 2.0 1.5 -0.6 -0.6 0.9 1.3 Private consumption 1.0 0.2 -1.3 -0.8 0.4 0.9 Gross fixed investment -0.3 1.4 -4.3 -3.4 1.2 2.0 Output gap -1.6 -0.8 -1.8 -2.8 -2.5 -2.1 Employment -0.5 0.3 -0.6 -0.9 0.0 0.4 Unemployment rate / 10.1 10.2 11.4 12.3 12.4 12.1 GDP deflator 0.8 1.2 1.3 1.2 1.3 1.3 General government structural balance -4.6 -3.7 -2.3 -1.4 -1.1 -0.8 General government gross debt 85.7 88.0 92.8 95.9 96.5 95.8 Current account balance 0.0 0.2 1.2 1.6 1.9 2.1 Real effective rate (2000=100)/ 95.3 95.0 90.3 92.2 … … Spanish unemployment falls Spain's National Statistics Institute INE released its quarterly Active Population Survey, showing a fall in unemployment by 225,000 in the second quarter to, which brings unemployment down to 5.98m or 26.3% after one quarter above the psychologically shocking 6m. On a yoy basis unemployment is still rising, but the rate is slowing down after peaking in the second quarter of 2012. Employment rose by 0.9% qoq, or 149,000. On an annual basis, employment was down by 3.6%, which includes a drop in public employment by 6.5%. The quality of employment deteriorated in Q2: the number of employees on a temporary contract rose by 162,000, while the number of indefinite contracts dropped by 50,000, and the number of self-employed people rose by 37,000. The active population dropped by 76,000 on a quarterly basis, and by 0.5% on a yearly basis. Speaking before Spain's parliamentary committee on economic affairs, Economy minister Luis de Guindos celebrated the first quarterly increase in occupation figures in 8 quarters, reports El País. De Guindos emphasised the quarterly drop in unemployment, while admitting that an unemployment rate above 26% remains unacceptable to the government which will "continue" to create jobs. The minister expects the data to improve further in the following quarters, as GDP becomes positive.

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German recovery solid, according to Ifo The German Ifo business index rose from 105.9 in June to 106.2 in July, the third straight-month increase, Reuters writes. The current conditions sub-index rose from 109.4 to 110.1, while the business outlook index fell one tick to 102.4. The article quotes an Ifo economist as saying that Ifo now expects the economy to have expanded by 0.9% in the second quarter, after 0.1% in Q1, with expected full year growth of 0.6%. Letta supports the idea of asset sales to lower debt La Stampa reports that Enrico Letta will follow Fabrizio Saccomanni’s idea of the sale of state shareholdings. Further information will be released during the next weeks, according to the Treasury. However, Letta also added the Italy must continue on fiscal consolidation, even if this is pretty unpopular, and trying to accompany it with economic-growth boosting policies. As the paper notes, there won’t be a specific target for the sales. Saccomanni says more spending cuts to come this year La Repubblica reports on a hearing in the Senate finance committee were Saccomanni said Italy had room for a new round of public spending cuts, but he ruled out a mini- budget for the current year, and confirmed that the government would stick to the fiscal targets. He said the spending cuts were necessary to achieve a meaningful reduction of the tax burden. Meanwhile, according to a Milano Finanza editorial, Italy cannot continue this way, saying it wants to cut taxes without following concrete actions. The ECB measures won’t be enough and the tax burden must be redistributed in order to support private firms. One way to do this would be to reduce statutory tax rates from proceeds from the fight against tax evasio Italians are facing a real tax burden of 54% due underground economy, study reveals Italian households and businesses face a real tax burden of 54% of GDP according to the retailers association Confcommercio. As Il Corriere della Sera reports, the figure comes after the underground economy was excluded from the calculations. Tax dodgers escape with a total of €272bn in evaded taxes every year, according to Confcommercio. The result is that underground economy weighs on the whole Italian system. The apparent tax burden for 2013 will be 44.6%, using the official method that includes the black market in its calculations. According to Attilio Befera, the director of the inland revenue service, Italy will bring in roughly €12-13bn in evaded taxes in 2013. Cyprus deposits continue to fall The euro-sceptical Open Europe blog picked up on the latest deposit statistics for Cyprus deposits and finds that €3.8bn have been moved out of the financial system to the bad bank. The graphs are also showing a reduction in deposits by about €1.5bn in June, similar to the month before, suggesting either continued deposit outflows despite capital controls households who rapidly wind down their savings. Neither presents a pleasant prognosis for the future of the Cypriot economy, so the blog. Greece clears last hurdle to unlock EU/IMF bailout funds Greece adopted on Thursday the last piece of legislation its international lenders required to release the next batch of rescue loans. Lawmakers convened during the parliamentary summer recess to approve a new tax code and amended the controversial

218 mobility scheme for civil servants. The bill's passage will unlock €5.8bn of bailout funds from the EFSF (€2.5bn), its national central banks (€1.5bn) and the IMF (€1.8bn), Reuters reports. Greek memorandum keeps emergency tax and foresees sale of Eurobank share Greece might have to keep the unpopular emergency tax on property next year and will have to sell a stake in Eurobank, one of its four so-called systemic lenders, to a foreign investor, according to the finalized version of Greece’s memorandum of understanding with its lenders, Kathimerini reports. Greece will have to keep the emergency property tax next year if the government is unable to create a new, single tax on property by the end of September. If ready in time, the new levy will have to raise €2.7bn in 2014. The pact between Greece and its lenders also foresees the sale of a substantial share in Eurobank, which has assets of almost €80bn, to a foreign investor by the end of March 2014 at the latest. The government will have to find the investor by the end of October so due diligence can begin the following month. Greece is also committed to making up any setbacks in its privatization process, such as the collapse of the deal to sell gas company DEPA, by speeding up the sale of its ports. The privatization target for this year is set at €1.6bn, increasing to €2.7bn next year, €3bn in 2015 and €2.1bn in 2016. The new memorandum also finalizes the parameters for plans to reduce civil servant numbers. A total of 25000 public sector workers will be placed in a mobility scheme by the end of the year. Of these, 12500 have to be found by the end of September. This year, 4000 civil servants will have to be fired and the total number of dismissals must rise to 15000 by the end of next year. Paul Krugman declares victory Paul Krugman has been making the point for some time that very old economic ideas have been entirely sufficient to explain the economics of this financial crisis. In his latest blog post, he recalls that the IS/LM framework of Hicks as been astonishingly successful in explaining what is happening at economies at the zero lower bound of interest rates. “…let me admit that I’m especially exasperated…. Look, please, at my [1999] Brookings Paper on the liquidity trap…. You’ll find me explaining that once you’re up against the zero lower bound: 1. Changes in government spending are still effective… with full Ricardian equivalence. 2. Unless you break that equivalence, it doesn’t matter how government spending is financed…. 3. Even very large increases in the monetary base will have no effect if seen as temporary. 4. Large increases in the base are likely to show up partly in increased cash holdings, partly in a large rise in excess bank reserves; this rise in excess reserves tells you nothing about whether the problem lies in the banking system…. So you can see why it was so frustrating…. Look, we have a framework here that has been a stunning success in practice. Why won’t you guys admit it?”

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Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.630 0.611 0.608 Italy 2.723 2.746 2.761 Spain 2.999 2.919 2.948 Portugal 4.824 4.814 4.859 Greece 8.629 8.585 8.60 Ireland 2.198 2.206 2.222 Belgium 0.916 0.889 0.884 Bund Yield 1.648 1.676 1.661 Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.318 1.3276

Yen 131.860 131.19

Pound 0.861 0.863

Swiss Franc 1.238 1.2339

ZC Inflation Swaps

previous last close

1 yr 1.54 1.5

2 yr 1.47 1.45

5 yr 1.6 1.59

10 yr 1.95 1.94

Euribor-OIS Spread

previous last close

1 Week -6.029 -6.629

1 Month -3.414 -3.414

3 Months 3.571 2.471

1 Year 31.786 31.786

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-07- 26.html?cHash=bd7f5e78704c1c1a7cc721ea39750b5b

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ft.com GlobalEconomy US Economy July 25, 2013 5:52 pm Summers dismissed QE effectiveness By Robin Harding in Washington

©Reuters Lawrence Summers Lawrence Summers made dismissive remarks about the effectiveness of quantitative easing at a conference in April, raising the possibility of a big shift in US monetary policy if he becomes chairman of the Federal Reserve. “QE in my view is less efficacious for the real economy than most people suppose,” said Mr Summers according to an official summary of his remarks at a conference organised in Santa Monica by Drobny Global, obtained by the Financial Times. More ON THIS STORY/ Senate letter backs Yellen for Fed role/ Slideshow Candidates to be the next US Fed chairman/ QE tapering requires delicate timing/ The A-List/ Global Insight Low inflation worries central bankers ON THIS TOPIC/ Recovery believers take over stocks rally/ US equity funds flooded with $17.5bn/ Investors show strong appetite for Tips/ Global Market Overview Stocks bounce on Bernanke comments IN US ECONOMY/ US new homes sales at 5-year high/ Obama to start new offensive on economy/ No money, but no one wants a haircut/ City of Detroit files for bankruptcy Mr Summers has emerged in recent days as a leading candidate to succeed Ben Bernanke as head of the world’s most important central bank. People briefed on the process say the Obama administration has framed its selection criteria in a way that makes Mr Summers, a former Treasury secretary, the obvious choice. Mr Summers – who served as President Barack Obama’s chief economic adviser from 2009-2010 – has seldom spoken in public about monetary policy. Markets have little sense of his current thinking and may be surprised by his apparently hawkish stance on QE. The disclosure of his remarks comes as the race for the Fed chairmanship is widely regarded as being between Mr Summers and Janet Yellen, the current Fed vice-chair, who has been an architect of its QE policies. The Fed is currently purchasing assets at a pace of $85bn a month. In his remarks in April, Mr Summers said it was likely either the economy would accelerate, or else estimates of its growth potential would have to come down.

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“If we have slow growth, we are not going to keep thinking that 5.5 per cent unemployment is normal,” said Mr Summers. “We are going to decide rightly or wrongly that the potential of the economy is less and therefore we are going to decide that we are closer to that potential and that is going to operate in favour of suggesting that we should normalise interest rates.” In his own words: Lawrence Summers // Read his columns from the FT’s Opinion page Mr Summers gave a highly optimistic outlook for the US economy – even more so than the Fed’s recent forecasts – saying the risks to growth are significantly to the upside. “I think the market is underestimating the pace at which the Fed will alter its current course and the consequences of that for interest rates,” he said. People who have discussed monetary policy with Mr Summers in recent years say the remarks reflect his views on QE, but he shares a similar economic framework to Mr Bernanke and Ms Yellen, and would keep monetary policy loose in order to support the economic recovery. “I think we are a long way from tight labour markets and therefore that the risks of acceleration in inflation are substantially less than many people suppose,” said Mr Summers. “Since our problem right now is that there isn’t enough pressure in labour and product markets, I don’t see the risk that we are headed for significant levels of inflation.” However, the people who have discussed policy with him say Mr Summers regards fiscal policy as a more effective tool than monetary policy. “More of what will determine things going forward will have to do with fiscal policy and that there is less efficacy from quantitative easing than is supposed,” he said in his Santa Monica remarks. Mr Summers said that while QE does little good it also does little harm. “If QE won’t have a large effect on demand, it will not have a large effect on inflation either,” he said. http://www.ft.com/intl/cms/s/0/01988daa-f540-11e2-94e9- 00144feabdc0.html#axzz2a8wDZxJU

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Morning papers: Senate letter backs Yellen for Fed role Today’s headlines brought to you by Investment Adviser: Friday, July 26, 2013. By Eleanor Lawrie | Published 08:44 | 0comments

A number of US Senate Democrats are circulating a letter supporting Janet Yellen to be the next chair of the Federal Reserve in an ominous sign for supporters of Larry Summers, reports the Financial Times. Ms Yellen, vice-chair of the Fed board, and Mr Summers, a former Treasury secretary and White House economic adviser, are the two leading candidates to replace Ben Bernanke. Equitable Life victims hit by ‘curse of data protection’ More than 200,000 victims of the Equitable Life collapse may never receive a penny in compensation because the Treasury has refused to access a disk containing their details, pleading data protection rules, it is claimed today, reports the Times. MPs on the Public Accounts Committee make the assertion in a strongly worded report setting out a string of failings in the running of the £1.5bn compensation scheme. Sterling falls as traders bet Bank of England will take further action to propel economy to ‘escape velocity’ Sterling fell against the dollar and the euro yesterday as traders bet the Bank of England will take further action to propel the economy to ‘escape velocity’, reports the Daily Mail. Official figures showed gross domestic product grew by 0.6 per cent in the second quarter of the year – double the 0.3 per cent expansion clocked up between January and March. Number of new homes hits 5-year high, says industry

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A total of 67,422 new homes were registered in the first half of this year with the National House Building Council (NHBC), the sector’s non-profit insurance and standards body. That was the highest such figure since 2008, reports The Daily Telegraph. Richard Tamayo, the NHBC’s commercial director, said: “While London remains an engine for growth we are seeing overall numbers up across the UK.” Church of England holds stake in Wonga financial backer The archbishop of Canterbury was forced to admit on Thursday that the Church of England holds a more than £1m investment in one of the main financial backers of Wonga, the payday lender the Most Rev Justin Welby had promised to compete “out of existence”, reports the Guardian. A spokesman for Lambeth Palace conceded that the Church of England’s £5bn pension fund, which has a policy that explicitly bans it from investing in payday lenders, holds an investment in Accel Partners, a US venture capital firm that is one of Wonga’s biggest investors. Spanish jobless rate has first drop in two years The sky-high jobless rate in Spain fell for the first time in two years, and by almost a full percentage point, yet remains above 26 per cent—more than twice the European average, reports The Wall Street Journal. Analysts were cautious about whether the quarterly figures reported Thursday represented a real upturn for the recession-hit country. At the same time, many economists and anticorruption specialists suggest that the problem may not be quite as bad as it seems. http://www.ftadviser.com/2013/07/26/investments/economic-indicators/morning- papers-senate-letter-backs-yellen-for-fed-role- QQACGWd0jfphzAPhIumpYJ/article.html

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ft.com Companies Financials Banks

July 25, 2013 11:25 pm US presses banks for multibillion payments over mortgage securities By Tom Braithwaite in New York Bank of America, JPMorgan Chase and Royal Bank of Scotland are being pressed for multibillion-dollar payments to the US government over toxic mortgage-backed securities, according to people familiar with negotiations. The Federal Housing Finance Agency, the US housing regulator, sued 18 international financial groups in 2011, alleging they broke federal securities laws in selling $200bn of mortgage-backed securities and demanding compensation for billions of dollars of losses. More ON THIS STORY/ UBS agrees to settle US housing claims/ Citi settles $3.5bn mortgage lawsuit/ Freddie Mac in line for $3.4bn from banks/ Wave of lawsuits engulfs troubled lenders/ Speculators aim to milk Fannie and Freddie ON THIS TOPIC/ Obama nominee backtracks on mortgage debt/ Obama picks Democrat to run housing agency/ Home refinancing rush hits bond investors/ US regulator points finger over Freddie and Fannie IN BANKS/ Hungarian banks fear forex loan measures/ Lazard overcomes tepid M&A market/ Investment banking division boosts Credit Suisse results/ Macquarie upbeat on full-year prospects This week UBS became the third group to settle with the FHFA, when the Swiss bank paid $885m in compensation for losses on securities where the underlying mortgages were often lent to people who could not make the repayments. Those bad loans breached “representations and warranties”, the FHFA alleged. On Thursday the FHFA made the UBS settlement amount public – it represents the first marker for how large other settlements could be and it is a much larger recovery than in other mortgage deals stemming from the crisis. UBS was a relatively small seller of MBS to Fannie Mae and Freddie Mac, the government-backed mortgage companies, with $6.4bn notional value. BofA, JPMorgan and RBS were much bigger, each with more than $30bn in notional value. If they settled in the same proportion, they would pay more than $4bn each to the FHFA, which oversees Fannie and Freddie, which were seized by the government during the crisis to prevent their failure. The calculation is imprecise: each security is different and it is possible that other banks could negotiate a better deal or win their cases outright in court. However, the banks have lost a series of procedural decisions in the last two years and GE Capital, Citigroup and now UBS have broken from the pack to end their court battles.

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In the case of RBS, the lawsuit is an example of a US government agency suing a bank that is majority-owned by the UK government and a payout in the same proportion of UBS would cost it $4.2bn, about 80 per cent of its 2012 operating profit. The amounts of previous settlements were kept private, partly because they were not material to GE or Citi. UBS announced on Monday that it had settled the case and was taking a litigation provision of about SFr700m ($746m). But it did not reveal the precise amount that was actually paid as some of it was covered by existing reserves. “The satisfactory resolution of this matter provides greater clarity and certainty in the marketplace and is in line with our responsibility for preserving and conserving Fannie Mae’s and Freddie Mac’s assets on behalf of taxpayers,” said Edward DeMarco, FHFA acting director, in a statement. BofA, JPMorgan and RBS declined to comment. FHFA declined to comment on other cases beyond saying it “remains committed to satisfactorily resolving” them. Quinn Emanuel and Kasowitz represented the FHFA. Gibson Dunn represented UBS. http://www.ft.com/intl/cms/s/0/b16b8d3e-f56a-11e2-b4f8- 00144feabdc0.html#axzz2a8wDZxJU

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ft.com GlobalEconomy EU Economy

July 25, 2013 9:45 pm IMF warns ECB may have to cut interest rates

BRUSSELS – The European Central Bank may have to cut interest rates and launch a fresh round of monetary easing to help boost the eurozone economy, which is still weighed down by spending cuts, the IMF said on Thursday. While recent purchasing managers’ surveys on the eurozone have suggested business activity is picking up, offering a glimmer of hope that the currency bloc can return to growth soon, the IMF does not see a recovery until 2014. More ON THIS TOPIC/ Boost for Osborne as IMF backs ‘Plan A’/ IMF slashes global growth forecasts/ IMF’s history suggests it seldom learns/ View from the US No more straws for Egypt IN EU ECONOMY/ Sweden’s economy shrinks unexpectedly/ Spain on track for return to growth/ Key ECB officials urge minutes publication/ China to freeze trade probes in solar deal In an assessment of the economy of the 17-country euro area, the Washington-based organisation said efforts to shore up public finances could cut growth by up to 1.25 percentage points this year. As a result, it forecast the eurozone would remain in recession for the second year in a row, contracting another 0.6 per cent before a return to 0.9 per cent growth in 2014. “For the area as a whole, the negative growth impact of consolidation could reach as much as 1-1.25 percentage points this year,” the IMF said. “Fiscal adjustment should be paced to avoid an excessive drag on growth.” With a risk of stagnation in the eurozone, and weak inflationary pressure, the IMF said the ECB should act to help growth with measures to reduce financial market “fragmentation” – a code word for highly disparate credit rates for companies in the north and south of the region. In depth Euro in crisis

As the debt storm spreads Europe’s leaders battle to save the eurozone The report added: “Taking its current approach forward, the ECB should ensure funding needs for weak but solvent banks through an additional LTRO of sufficient tenor,” the report said, referring to the bank’s ultra-cheap loans to banks, or Long-Term Refinancing Operations.

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“This would be most effective if accompanied by lower collateral haircuts, particularly on small and medium-sized enterprise loans,” it said. The report praised the extra time that EU finance ministers had given several eurozone countries to reduce their budget deficits as a way to support demand, but said even longer deadlines for some governments may be needed. “Given weak growth prospects, these deadlines may still prove to be overly ambitious in some cases, and even more flexibility may be useful, particularly if countries use that fiscal space to implement ambitious structural reforms, or to recapitalise viable banks,” the IMF said. To help stem the growing risk of stagnation, individual eurozone governments will be required to continue with reforms and go ahead with plans to further integrate banks. The banking union is particularly important as it will help identify which of the 200 larger banks still have problems and hidden losses, recapitalise them and get credit going again to small and medium-sized companies. http://www.ft.com/intl/cms/s/0/d6d2b3f0-f546-11e2-b4f8- 00144feabdc0.html#axzz2aWmEE0WC

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July 25, 2013, 8:46 am 40 Comments Deficits and Interest Rates — The History I occasionally see people arguing that the historical association — that is, pre-crisis — between budget balances and interest rates presents some kind of challenge to conventional macroeconomics. (Oddly, you see this from both left and right; the Wall Street Journal, for example, was very much for deficits before it was against them). But is there really any problem? Let’s start in the mid-1980s; huge changes in expected inflation make it harder to parse what went before. Here’s what you see (the fiscal balance is shown so that an upward movement is a fall in the deficit or a rise in the surplus):

Clearly, the association goes the “wrong” way: bigger surpluses (lower deficits) are, on average, associated with higher, not lower, interest rates. Macroeconomics is all wrong! Or maybe not. Look at the recession bars — and bear in mind that each recession over this period was followed by an extended “jobless recovery” that felt like a continuing recession, and was met with further Fed easing. What’s really going on here is that the business cycle is driving both deficits and interest rates. The recession of 1990-91 (driven by the S&L crisis and a burst bubble in commercial real estate) drove up the deficit, and also led to Fed easing; the recession of 2001 (dotcoms and telecomms) did the same; the recession of 2007-9 (end of the world, basically) did it on a scale that pushed the deficit to record levels and interest rates down to zero.

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There isn’t a puzzle here unless you insist on believing that budget deficits are events that have nothing to do with what is going on in the larger economy. http://krugman.blogs.nytimes.com/2013/07/25/deficits-and-interest-rates-the-history/

July 25, 2013, 8:14 am 68 Comments Gimme That Old-Time Macroeconomics

Historical Statistics of the United States, Millennial Edition; Bureau of Labor Statistics Both Steve Benen and Ed Kilgore get annoyed at fellow journalists complaining that there aren’t any “new ideas” in Obama’s latest. But why should there be? It was clear early on that this was a crisis very much in the mold of previous financial crises. Once you realized that financial instruments issued by shadow banks — especially repo, overnight loans secured by other assets — were playing essentially the same role as deposits in previous banking crises, it was clear that we already had all the tools we needed to make sense of what was going on. And we also had all the tools we needed to formulate an intelligent policy response — all the tools we needed, that is, except a helpful economics profession and policymakers with a good sense of whose advice to take. As Mark Thoma memorably remarked, new economic thinking appeared to consist largely of rereading old books. Brad DeLong says that it was all in Walter Bagehot; I think that this is true of the financial crisis of 2008, but that to understand the persistence of the slump we need Irving Fisher from 1933 and John Maynard Keynes from 1936. But anyway, this is not new terrain. True, there have been some sort-of new ideas in the crisis: the idea that cutting spending is actually expansionary (although Herbert Hoover was all over that), the notion that

230 there is a magic anti-growth cliff at 90 percent debt/GDP. But these new ideas were wrong, and have collapsed in the face of the evidence. Maybe we need new ways to phrase our arguments; that’s what Obama was doing yesterday, and I’m still trying to figure out whether his new take is useful. But the amazing thing about this slump has been how utterly comprehensible it is — and the absolute refusal of so many people, economists and not, to accept a framework that has worked just fine. http://krugman.blogs.nytimes.com/2013/07/25/gimme-that-old-time-macroeconomics/

July 24, 2013, 1:21 pm 162 Comments Been There, Done That: Monetary and Fiscal Policy Edition Noah Smith has a nice takedown of Martin Feldstein’s latest, which is the claim that the reason a vast expansion of the Fed’s balance sheet has produced no inflationary effect at all is the 0.25 percent — that’s right, 0.25 percent — rate of interest the Fed is paying on excess reserves. Even if this were right, wouldn’t it suggest that the Fed’s expansion poses no inflationary risk? I mean, if all that alleged pressure can be completely contained with a 1/4 percent interest rate, how big a problem can it be? But it’s not right, as Noah shows logically; and of course the example of Japan, which did massive QE without paying interest on reserves, and saw nothing happen, reinforces the point. The remarkable thing is the desperation with which inflationistas keep conjuring up new explanations for a result –the failure of large increases in the monetary base to have an inflationary impact — that was fully predicted, in advance, by simple economic models. Instead of saying that a simple IS-LM framework, or a New Keynesian analysis along the same general lines, has worked very well — and that whatever other model they were using failed the test — they keep coming up with excuses. It’s Obamacare! It’s interest on reserves! It’s the decline of traditional marriage! OK, they haven’t used that last one yet, but give them time. And let me admit that I’m especially exasperated — actually, about the fiscal as well as monetary arguments — because I went over all this ground fifteen years ago. Look, please, at my Brookings Paper on the liquidity trap (pdf), especially pp. 155-159. (Those are pages in the volume — the paper isn’t that long). You’ll find me explaining that once you’re up against the zero lower bound: 1. Changes in government spending are still effective, with a multiplier of 1, even with full Ricardian equivalence. 2. Unless you break that equivalence, it doesn’t matter how government spending is financed; “helicopter money” makes no difference.

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3. Even very large increases in the monetary base will have no effect if seen as temporary. 4. Large increases in the base are likely to show up partly in increased cash holdings, partly in a large rise in excess bank reserves; this rise in excess reserves tells you nothing about whether the problem lies in the banking system, since it will happen even if the banks are perfectly OK. So you can see why it was so frustrating to see reputable economists get all of these things wrong in the early years of the crisis; and some of them seem determined to keep getting them wrong even now. Look, we have a framework here that has been a stunning success in practice. Why won’t you guys admit it? http://krugman.blogs.nytimes.com/2013/07/24/been-there-done-that-monetary-and- fiscal-policy-edition/?_r=0

July 23, 2013, 4:04 am 157 Comments This Time Was Predictable Bruce Bartlett continues his interesting series on inflation panic, this time focusing on the economists and politicians who keep predicting runaway inflation year after year after year, and never seem to acknowledge having been wrong. I thought his analogy between Shadowstats and the “unskewed” polls predicting a Romney victory was especially apt. But I do have a slight quarrel with Bartlett, who despite everything, I think, gives the inflationistas too much credit. First,he writes: When the most recent recession began in December 2007, there was no reason at first to believe that it was any different from those that have taken place about every six years in the postwar era. Actually, there was. Long before Reinhart and Rogoff circulated their piece on the aftermath of financial crises (http://www.nber.org/papers/w14656) — an excellent piece of work, not to be confused with their unfortunately influential debt paper — it was already obvious to many people that we were looking at a “postmodern” recession like 1990-91 or 2001, which was likely to be followed by an extended jobless recovery. That is, this was not going to be a Fed-generated slump like 1981-82, which would be followed by a quick rebound once the Fed relented; it was a case of private-sector overreach, and was likely to go on for a long time. Bartlett then goes on to say During the inflation of the 1970s, most economists became convinced that if the Fed adds too much money and credit to the financial system it will inevitably cause prices to rise. Since the increase in the money supply in 2008 and 2009 was unprecedented, many economists reacted fearfully to the Fed’s actions.

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Given the order of magnitude of the increase in bank reserves, from virtually nothing to more than $1 trillion almost overnight and now to more than $2 trillion, it was not unreasonable to be concerned about the potential for Zimbabwe-style hyperinflation. Yes, it was unreasonable. If you had paid any attention to Japan, or to the revived theory of the zero lower bound (starting here) inspired by Japan’s experience, you knew full well that the Fed’s expanded balance sheet was mainly going to just sit there. And that, in turn, gets at the true sin of the inflationphobes. They were wrong; well, that happens to everyone now and then. But the question is what you do when events prove your doctrine wrong — especially when they unfold almost exactly the way people with a different doctrine predicted. Do you admit that maybe your premises were misguided? Do you admit that maybe those other guys were on to something? Or do you just keep predicting the same thing, never admitting your past mistakes? Guess what the answer turned out to be. http://krugman.blogs.nytimes.com/2013/07/23/this-time-was-predictable/

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Daily Morning Newsbriefing

July 25, 2013 Signs of life in the eurozone There were some good data for the eurozone, pointing to a recovery in economic growth. The Wall Street Journal and other media report on the rise of the PMI index for the eurozone to above the critical level of 50, in this case 50.4, for July, amid signs of a rise in consumer confidence, and manufacturing activity. Services are still in decline. The data are consistent with wafer-thin levels of economic expansion, as the WSJ put it, from the start of the third quarter. The Journal also pointed to data showing that the eurozone economy had shrank for 18 straight months. Businesses continue to cut jobs, but at the slowest pace since March 2012. Unemployment rates continue to rise for a while before they stabilise. Geographically, the recovery in the PMI was driven by Germany. Germany’s PMI was at 53.8. The French PMI rose to from 47.4 in June to 48.8 in July. As Frankfurter Allgemeine reports Pierre Moscovici is now forecasting second quarter GDP growth of 0.2%. There is also some good economic news from Spain and Italy. The Bank of Spain's quarterly economic report included in its July-August Economic Bulletin estimates GDP fell by only 0.1% in the second quarter of 2013, compared with a 0.5% drop in the first quarter. On a year-on-year basis, the GDP dropped by 1.8%. Net exports contributed 0.4% to the quarterly change in GDP while internal demand dropped by 0.6% compared to 0.7% in the previous quarter. Cinco Días interprets the data as "bottoming out" of the recession in Spain, which El País characterises as the longest in Spain's democratic history as this is the 8th consecutive quarter of negative growth. Italy’s retail sales rose during May by 0.1%, but were still down yoy by 1.1%, ISTAT said, as reported by La Repubblica. Sales of food dropped by 1.6% in the first five months of 2013, according to ISTAT, relative to the same period in 2012. Il Sole 24 Ore reports figures from Federconsumatori, according to which 62% of Italian households reduced food purchases, and over 6.5mn have decided to shop in discount and low-cost markets to cut expenses during the crisis. The data show a fall in food purchases per household by €2,161 between 2012 and 2013. When we read the news coverage about the nearing end of the recession in the eurozone, we were reminded of Jeff Frankel’s comment in yesterday’s briefing, who said it was silly to define recessions as a fall in GDP for two consecutive quarters, which means that you prematurely celebrate upturns before they become broad-based. What you have to look at, he wrote, is the cycle in its entirety. He uses the NBER definition of a recession, according to which a recession is defined as a fall in economic activity between the peak and the trough of the cycle, but this relates to a much wider definition than just GDP. On such a wider measures, the eurozone recession started in 2008 and is still ongoing, given the tightness of labour markets and credit conditions. It

234 will probably turn this year, but not quite yet. And there are further risks involved, as the next two stories show. Further tightening in credit standards Reuters reports on the ECB’s bank lending survey, according to which the funding conditions for banks improved during Q2, but banks nevertheless tightened lending standards for companies and mortgages. More tightening is expected for the July- September period. While tightening standards for corporate borrowing and house loans, banks eased credit standards for consumer credit for the first time since 2007. The ECB said that a net 7% of the euro zone banks that took part in the survey tightened their criteria for firms to borrow in the second quarter, the same as in the first quarter. The Wall Street Journal added that banks expect a further weakening of demand from companies, and a further rise in lending standards. Where Germany is at risk Frankfurter Allgemeine has a report about the impact of the slowdown of China and other newly industrialised countries on the demand for German exports. The slowdown in China affects particularly investment goods, Germany’s main export category to the country, as the Chinese industrial sector is slowing down markedly. The growth in China is expected to fall further to an (official) 7% as the country tries a careful rebalancing act from investment to consumption. The article quotes various analysts from Japan and Singapore who fear a hard landing of the Chinese economy. The article also mentions the fall in economic growth in Brasil, and the slowdown in Russia, again with a disproportionately large effect on German exporters. Chairman of Spain's Constitutional Court impugned The controversy over the PP membership of the Chairman of Spain's Constitutional Court Francisco López de los Cobos, continues to intensify. El País reports that the regional governments of Catalonia and Andalusia have initiated the process to impugn de los Cobos in all Constitutional Court cases brought by the People's Party, notably the Catalan region's education law which was challenged before the Constitutional Court by the Catalan PP. Meanwhile, in the parliament, the PP used its 5:4 majority on the board of the lower house to block an opposition request that de los Cobos explain to the Parliament why he didn't disclose his PP membership during his confirmation hearings at the end of 2010., reports El Mundo. The Constitutional Court's own legal precedent interprets the incompatibiity rules as allowing political party membership, though not leadership positions in a political party. The PP has reacted to the controversi as to a political witch hunt, with the best line in defence of de los Cobos being provided by PP leader Esteban González Pons, who said last week "at this rate, it will become a punishable offence to vote for the PP", reported El País. Letta blames underground economy for lost competitiveness Il Corriere della Sera reports. Like his predecessor Mario Monti, he blames tax evaders and pledges to recuperate financial resources in tax havens like Switzerland. Official taxes are high in Italy because not everybody pays them. According to Il Corriere, Italy has the world’s second largest underground economy in proportion to GDP, just after Greece. The size of the economy outside the legal tax system is reportedly estimated at 18% of GDP. Unpaid taxes, including VAT, are put at €50bn for 2011. Simone Spetia commented on Radio24 that the biggest problem for Italy’s competitiveness was not the underground economy, but a byzantine justice system,

235 a vicious mingling between banks and politics, an underdeveloped South, a regulatory system full of obsolete laws, and a closed labour market. And Letta has not yet adopted measures to fight these gaps, Spetia writes. Oh dear. Whenever he hear that an Italian prime minister blames something or someone, then he is merely trying to excuse his own failure. Letta’s diagnosis is typical for an unbelievable complacency among Italy’s political elite. An underground economy is rarely the cause of anything, but usually the effect of a decrepit regulatory and tax system. It is Letta’s job to fix that, but he can’t because his own party does not let him. Instead, he continues where Mario Monti left off, by dealing with the symptoms. Greece to amend labour law Greece is to amend the bill for placing public sector workers in the labour mobility scheme and pass through parliament today to get approval of the next aid tranche on Monday, Kathimerini reports. The legislation overrides the one passed last week which protects civil servants with postgraduate degrees and those with disabilities or other social needs from being forced into a labour reserve. A European official told Kathimerini that there were “too many exceptions” in Greece’s labour mobility plan while the Greek Finance Ministry sources said that the exceptions only affected about 80 people. Eurogroup chief Jeroen Dijsselbloem said in a statement that Greece had completed all other “prior actions” demanded by the troika. The Euro Working Group will reconvene on Friday, after the amendment has been passed in the Greek Parliament, to approve the release of €2.5bn from the EFSF and another €1.5bn of bond profit returns from eurozone central banks. The process is not due to be completed until Monday, when a compliance report will be issued and national parliaments will also give their approval for the disbursement. Also on Monday, the IMF’s executive board is due to meet to decide on the transfer of its share of the latest bailout tranche, worth €1.8bn, to Greece. French employers target pensioners The French employers’ organisation MEDEF presented the government their pension reform proposals to close the financing gap until 2020. According to Les Echos MEDEF suggests to accelerate the lengthening of the contribution period to reach 44 as from 2020. They also target current pensioners, which are to contribute for three years through partial freeze of their pensions, an increase in social charges and reduction in niches. In an interview with Les Echos the vice-president Jean-Francois Pilliard said they are only willing to accept higher pension contributions if the government is lowering labour costs. EU Commission approves restructuring of three Portuguese banks The European Commission on Wednesday said the three Portuguese banks that tapped bailout funds are on the right path to become viable by cutting costs and selling assets without needing to seek additional state aid, Reuters reports. The sector borrowed around half of the €12bn earmarked for banks as they struggled under a credit squeeze and rising bad loans amid the country's biggest recession since the 1970s. The Commission said it has approved the restructuring plans for CGD and Banco BPI, adding that regarding BCP it had finalised discussions with Portuguese authorities and will adopt a decision on the bank's plans in coming weeks. Discussions between the Commission and Portuguese authorities about the fourth Portuguese bank having

236 received state aid--Banif--continue, because that bank received state aid later than the other three banks, the commission said. Portugal’s struggle to revive economy A comment in the FAZ says that Portugal deserves to be trusted but that the country will find it difficult to revive its economy. In the last five crisis years, 9000 companies were destroyed in Portugal, more than in Spain. Portugal’s competitiveness is threatened, not only because of internal circumstances but also because it faces new competitors with new EU entries such as Croatia, so the article. This will weigh on the ‘new’ government and whether they succeed to turn the economy around. Merkel’s defence minister in trouble This is not a good moment for a political crisis, but it seems that Thomas de Maiziere, Angela Merkel’s defence minister, has misled the Bundestag when he said he had no information about a massive cost overrun of a defence project involving unmanned aircraft. Bild reports on a hearing in the Bundestag, during which an email surfaced, written by a ministry staffer and close associate of de Maiziere in December 2012, in which he warned of a massive cost overran of the Euro Hawk project. The cost overshoot was so significant, the email said, that there would have to be a new political decision about the project. The staffer also said that he would not recommend deciding in favour of the project if these latest data are confirmed (which subsequently they have). Bild asks the question, what did de Maiziere know, and whether he lied to the Bundestag? Bild says de Maiziere was not clinging on to the literal definition of his statement to the Bundestag, in which he said he had only heard of the “insoluble” problems of the Euro Hawk project in May 2013 – which is not the same as saying that he had not heard anything at all. The CDU is now lining up behind the defence minister, but as Nicolas Blome, the pro-Merkel Bild commentator, has pointed out, the Merkel government is now hit by a double-whammy ahead of the elections – the Euro Hawk crisis, and criticism of its handling of the wiretapping scandal following the Snowden allegations, which has given rise to a media shit storm in Germany. Munchau on how to get rid of Merkel In his Spiegel column, Wolfgang Munchau noted that the opposition has so far failed to gain any traction on Merkel’s handling of the euro crisis, but succeeded admirably in identifying Merkel’s inaction during the latest spying scandal. The scandal itself will probably not be enough for the opposition the election, as the public outrage probably won’t last that long. But the opposition has been able to thrown doubts about Merkel’s leadership qualities. This should be the context, in which they should raise the eurozone crisis, as they now seem to have develop a coherent narrative. The crisis itself is too complicated for an election campaign, but the message that Merkel is delaying very obvious decisions on Greece, Cyprus and Portugal because of her own re-election campaign is relatively easy to bring across. Wren-Lewis on fiscal dominance Simon Wren-Lewis has a piece on why the ECB keeps on making statements about fiscal policy. He starts with an acknowledgement that fiscal policy can affect monetary policy. For example, a central bank should warned against austerity at the ZLB, as this would serious constrain the impact of monetary policy. In the ECB’s case, the ostensible reason is a fear of fiscal dominance – that large budget deficits will produce inflation – but Wren-Lewis makes the point that the ECB has less to fear from fiscal dominance than other central banks, given its strong degree of independence.

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“So we should see much less of a concern about budget deficits from the ECB than from other central banks, yet we actually see the opposite. I can think of only three explanations for this apparent contradiction. The first is that the ECB does not understand its own position. The second is that the ECB is really concerned about the distributional effects if countries pursue different fiscal paths. Yet if that was the case, they should be focusing on relative fiscal positions, rather than always suggesting lower deficits are good. The third possibility is that the ECB is using its position of authority to pursue other economic or political goals that have nothing to do with its mandate.” He suggests that the third explanation is the one. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.662 0.630 0.634 Italy 2.817 2.806 2.787 Spain 3.103 2.999 3.041 Portugal 4.918 4.824 5.083 Greece 8.729 8.629 8.62 Ireland 2.284 2.198 2.180 Belgium 0.984 0.916 0.931 Bund Yield 1.552 1.648 1.667

Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.324 1.3211

Yen 132.520 131.87

Pound 0.861 0.8603

Swiss Franc 1.239 1.2375

ZC Inflation Swaps

previous last close

1 yr 1.55 1.54

2 yr 1.48 1.47

5 yr 1.6 1.6

10 yr 1.95 1.95

Euribor-OIS Spread

previous last close

1 Week -6.129 -6.629

1 Month -3.514 -4.014

3 Months 1.214 1.214

1 Year 30.343 28.643

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Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-07- 25.html?cHash=4a5b236caeba29ea90d37a01979bbec3 mainly macro //Comment on macroeconomic issues Crossing the line at the ECB Simon Wren-Lewis

Wednesday, 24 July 2013 Just how much should central bankers express views about fiscal policy? One reasonable response is not at all. Yet fiscal actions can have implications for monetary policy, so vows of silence are both difficult to sustain, and potentially withhold important information from the public. For example, I have recently suggested that it is almost undeniable that fiscal austerity when interest rates are at the Zero Lower Bound (ZLB) makes it more difficult for monetary policy to do its job. If I was a monetary policy maker, I would want to make that clear to the public, if only to avoid getting all the blame when things go wrong. I have praised Ben Bernanke’s recent comments to that effect, which he reaffirmed more recently. Of course, outside the Eurozone, it would be seen as wrong for central bankers to condemn these policies, but it must be right for them to point out that it causes them difficulties. So there should not be a taboo on central bankers talking about fiscal policy, when it influences their ability to do their job. Policy makers at the European Central Bank (ECB) are particularly fond of talking about fiscal policy and structural reform. Here is just one recent example, but the ECB’s own research confirms that “the ECB communicates intensively on fiscal policies in both positive as well as normative terms. Other central banks more typically refer to fiscal policy when describing foreign developments relevant to domestic macroeconomic developments, when using fiscal policy as input to forecasts, or when referring to the use of government debt instruments in monetary policy operations.” So why does the ECB stand out here? One hypothesis that appears not to work is that the ECB has been dragged into commenting on fiscal issues by the Eurozone crisis. We could question, as Carl Whelan does (pdf), why the ECB is part of the Troika? Was it dragged, or did it invite itself? However, as the ECB research cited above shows, the ECB’s unusual interest in making normative statements on fiscal policy predate this crisis period. One strong clue is the nature of these interventions. Bernanke warns that excessive fiscal tightness could slow down the US recovery, and because of the ZLB the Fed’s ability to counteract this is at least uncertain. The ECB always urges European governments to make fiscal policy more restrictive. That suggests that it either has a completely different view about the macroeconomic conjuncture in the Eurozone compared to the US (unlikely), or that it believes in expansionary austerity (see below), or that it is concerned about something else (much more likely). The something else which many economists would point to is fiscal dominance. The ECB and many other European policymakers seem obsessed by the fear that monetary policy will not be able to do its job because of excessive budget deficits in individual Euro member states. So how reasonable is this fear, and is the Eurozone special in this respect, so as to explain the ECB’s unusually vocal behaviour compared to other central banks? The answer is I believe quite clear - the ECB has less to fear from fiscal dominance than any other central bank!

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It was partly to show this that I wrote two recent posts on budget deficits and inflation. In the first, I made the widely accepted point that monetary policy can always neutralise the impact of higher debt on inflation by raising interest rates, if fiscal policy makers raise taxes or cut spending sufficiently to stabilise debt. Once you eliminate market panics through OMT, then it is absolutely clear that all Eurozone countries are doing that. So there is no present threat of fiscal dominance. But imagine there was. In a second post I looked at the possibility that a fiscal policy maker might not even attempt to stabilise debt. In that case, a conflict between fiscal and monetary policy could emerge. Yet I argued that in any resulting game of chicken, if the central bank was able and prepared to allow governments to default and not monetise the deficit, it could retain control of inflation. Now in nearly all countries the government has ultimate power, so it could force the central bank’s hand (although at perhaps a very high political cost). However the one exception is the ECB. The ECB is in a better position to resist fiscal dominance than any other central bank. So we should see much less of a concern about budget deficits from the ECB than from other central banks, yet we actually see the opposite. I can think of only three explanations for this apparent contradiction. The first is that the ECB does not understand its own position. The second is that the ECB is really concerned about the distributional effects if countries pursue different fiscal paths. Yet if that was the case, they should be focusing on relative fiscal positions, rather than always suggesting lower deficits are good. The third possibility is that the ECB is using its position of authority to pursue other economic or political goals that have nothing to do with its mandate. The ECB is also fairly unique in its lack of accountability. Perhaps for that reason, it feels no inhibition in being free with its opinions on economic issues, even when they have no bearing on its ability to control inflation.

This third explanation may also help explain the reluctance of the ECB to act as a sovereign lender of last resort. We had two years of an existential Euro crisis before OMT was introduced. The argument that is generally used to explain this reluctance is the ECB’s fear of fiscal dominance. However, as I have argued, the ECB has much less to fear on this account than others central banks, yet other banks were quick to undertake Quantitative Easing. As this piece reminds us, and as is noted by Peter Dorman here, pressure from the bond market can be very useful in helping achieve certain economic and political goals. So even though these goals have nothing to do with the ECB’s mandate, the ECB might be reluctant to see those pressures reduced by its own actions. I would like to be wrong about this. But if I am not, I think it is important to understand what it reveals. To quote Peter Dorman: “In their own minds they probably see neoliberal reforms as self-evidently beneficial to the point that there is no need to spell them out or argue for them: everyone they know understands that this has to be the solution.” They are just giving good economic advice, advice that is needed because politicians too often respond to vested interests rather than sound economic reasoning. If this reading is correct, then we have a serious problem. In this view about what is good economics, Keynes has completely disappeared. Not only the Keynes who showed why cutting government spending at the ZLB was a foolish thing to do, but also the Keynes who emphasised that prices in financial markets may not reflect fundamentals but instead just what market participants thought that other participants would do.[1] This is the Keynes whose ideas (or interpretation of those ideas) feature heavily, and very positively, in every economics textbook, including those used by those teaching in Eurozone countries. So what remains a real mystery to me is how the elite who make policy in the Eurozone can feel it is legitimate to promote a view about what is good economics which contradicts what economists in the Eurozone teach.

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For central bankers to give advice on economic issues that are outside their remit but which pretty well every economist would sign up to is one thing. Of course central bankers will have their own private views on more controversial matters. However it seems to me that to give public advice on economic issues that are outside their remit which are also highly controversial (and contradict what is in the textbooks) seems to me to be crossing a line which it is very dangerous to cross.

[1] This is the insight behind the idea, emphasised by De Grauwe, that there may be a ‘bad equilibrium’ in the market for Eurozone government debt, which the ECB through OMT can help avoid. (For those unfamiliar with this idea, a good place to start is this piece by De Grauwe and Li.) It is interesting that the ECB, in justifying OMT, tends to favour the argument that the market has unjustified fears of Euro break up, rather than that the market is not looking at fundamentals. It is using an argument that remains consistent with Ordoliberal ideas. http://mainlymacro.blogspot.it/2013/07/crossing-line-at- ecb.html?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed:+Mainly Macro+(mainly+macro)

ft.com Markets Currencies Last updated: July 24, 2013 8:51 pm Euro helped by signs of eurozone recovery By Neil Dennis The euro saw choppy trading on Wednesday as investors digested news that German business activity had expanded more than expected in July. The single currency touched a one-month high against the dollar of $1.3256 before slipping back below $1.32 in US trading hours. The euro had been lower ahead of the release of data that showed recovery was accelerating in the eurozone’s largest economy. More ON THIS STORY/ Letter Quantitative easing, closer to home/ Ian Bremmer and David Petraeus Abe’s win is great news/ BoE tensions as policy debate rages on/ OECD unveils global crackdown over tax/ Jobless benefit claims in UK fall steeply ON THIS TOPIC/ Eurozone data buoy hopes of economic recovery/ Eurozone factory downturn eases in June/ Central & eastern Europe Auto industry/ Central & eastern Europe Electrical goods IN CURRENCIES/ Sterling climbs ahead of UK growth data/ Rupee climbs on RBI’s latest strategy/ Texan accused over alleged Bitcoin Ponzi scheme/ Dollar holds near monthly low Flash purchasing manager surveys for July showed that the composite index of manufacturing and services rose from 50.4 in June to 52.8. Manufacturing PMI rose from 48.6 to 50.3, beating an average forecast of 49.2, while services rose from 50.4 to 52.5, easily beating the forecast of 50.8.

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Any number above 50 indicates expanding activity. French PMI, although not rising into expansion territory, climbed more than expected, fuelling hopes for another of the region’s core economies. Overall, the composite eurozone PMI for manufacturing and services bounced for a fourth consecutive month from 48.9 in June to 50.4, exceeding the 49.1 consensus forecast. “The figures clearly support the notion that the eurozone as a whole is leaving recession behind,” said Martin van Vliet at ING. “This is encouraging, but we doubt the region is about to embark on a sustainable recovery.” The euro climbed 0.1 per cent to £0.8612 against the pound and 0.8 per cent at Y132.52 versus the yen. Conversely, the Australian and New Zealand dollars fell in reaction to weak industrial activity data from China . Manufacturing activity in July, for purchasing managers surveyed by HSBC/Markit, fell further into territory that indicates contraction. The index eased from 48.2 in the previous month to 47.7, but had been expected to hold the June level. It was the index’s lowest level in a year and marked the third month below 50. The Aussie fell 0.9 per cent to $0.9216 against the US dollar, hit also by weaker than expected inflation data. The Kiwi lost 0.4 per cent to $0.7968. The dollar index rallied 0.3 per cent after hitting a one-month low on Tuesday. http://www.ft.com/intl/cms/s/0/58eb30fa-f435-11e2-a62e- 00144feabdc0.html#axzz2ZlHBlKkT

ft.com Comment Columnists

July 24, 2013 6:49 pm Banks should keep out of mines and warehouses

By John Gapper When Wall Street launches into unlikely enterprises, it is time, once again, to start worrying

©Ingram Pinn When Goldman Sachs bought the commodity trading house J Aron in 1981, it also took on Lloyd Blankfein, then a salesman of silver coins. Thirty-two years later, Mr 242

Blankfein is Goldman’s chairman and chief executive and the bank owns, among other commodity assets, some aluminium warehouses near the ailing city of Detroit. The process by which some of the biggest US banks came to own not only physical commodities but infrastructure such as oil tankers and pipelines is a fine example of mission creep since they were split up by the Glass-Steagall Act of 1933. One can see how they got there, but it is a peculiar – and not very desirable – outcome. More ON THIS STORY/ US watchdog acts on metals warehousing/ US banks eye metal storage exit/ Metals pricing under threat from warehousing rule change/ Metals warehouses Storage stacks up for traders/ Goldman and JPMorgan enter metal warehousing JOHN GAPPER/ The superstar still reigns supreme over publishing/ BP as bad at capping payouts as oil wells/ Regulators are closing in on banks/ City investor protection rules go too far What would happen if a Morgan Stanley oil tanker ran aground (it partly owns a company with a fleet of 120 tankers), or there were a fatal accident at a Goldman coal mine (it has a stake in Colombian mines)? Most people would be baffled by what Wall Street was doing at the scene and it could easily spark a crisis of confidence at a too- big-to-fail financial institution. In September the Federal Reserve will have a choice of whether to allow banks to carry on as before, or roll back the boundaries of what they do. It should employ common sense and keep them out of activities that have only a tangential relationship to banking. True, the roots of merchant banks lie in trading and finance of physical commodities. Institutions such as Baring Brothers started as commodity houses, and Salomon Brothers – now part of Citigroup – was bought by Phibro, the commodity trader, in the year that Goldman bought J Aron. But things have changed. First, brokers used to be tiny in comparison with deposit- taking banks that had large balance sheets and the implicit backing of taxpayers. Commodity trading spilled into systemically important banks with the dismantling of Glass-Steagall and the 2008 conversion of Morgan Stanley and Goldman to bank holding companies. Second, banks have moved on from trading commodities such as oil and metals, which has logic if they trade derivatives, to owning ships, mines and warehouses. In some cases, they have evaded the regulatory barriers by using their “merchant banking” (private equity) arms to take ownership of the latter under another guise. Goldman’s involvement in aluminium shows how this can work. It was among banks that saw an opportunity after the 2008 crisis, when the price of aluminium fell and surplus stocks built up. Banks and commodity groups could profit from the wide gap between futures and spot prices by financing an arbitrage trade for their clients. This left a pile of aluminium in the hands of traders, which needed to be stored in warehouses. Banks realised that warehouses were in high demand and bought such facilities through their private equity arms in 2010. They were required by law to run trading operations and warehouses separately but they had two revenue streams. Three years later, Goldman and JPMorgan Chase are preparing to sell the warehouses again but face a Senate inquiry into their activities. Companies including MillerCoors

243 and North American Breweries complain that delays in being able to obtain metal from warehouses have added $3bn to their costs and raised the price of aluminium cans. Given that the aluminium price has fallen further than the premium for getting it promptly has risen, the beer guys’ lament deserves to be played on a very small violin. They could have bought at the bottom of the market themselves, rather than letting speculators do so and then complaining loudly. Nonetheless, there are murky aspects to aluminium trading. Banks and commodity trading groups can store some of their metal in private facilities – “dark inventory” – in order to make it appear scarce. Furthermore, the fact that banks’ investment arms decided to acquire assets that dovetailed so neatly with their trading operations feels too convenient for comfort. This abrupt integration of metals trading and storage echoes how banks piled into subprime mortgages before the 2008 crisis, buying origination and servicing companies to securitise the loans. When Wall Street takes a detour from trading into surprising new activities, sound the alarm bell. Commercial banks used to be barred from holding more than 5 per cent of industrial companies, partly to prevent a repetition of the way that JPMorgan took control of swaths of the steel and railway industries in the late 19th century. The rules were relaxed by the Gramm-Leach-Bliley Act of 1999, giving banks more leeway. Even so, when the Fed permitted banks including JPMorgan Chase to trade in commodities, it specified that they should not own or operate storage and transport facilities. Somehow, Wall Street has managed to find various routes around the Fed’s original intentions. Some banks have used merchant bank powers under the 1999 act to “temporarily” acquire industrial assets that are related to trading. Goldman and Morgan Stanley were allowed to keep existing operations when they converted to banks, while JPMorgan gained approval under another clause. No doubt Wall Street has followed the letter of the law after employing battalions of lawyers to study it minutely, but the result is as if the intended barriers did not exist. Despite the Fed’s efforts not to allow banks to own commodity infrastructure, they plainly do so. There is no clear need for them to own warehouses and mines, but sound reasons why they should not, from systemic risk to the difficulty of supervision. The Fed should enforce its will. http://www.ft.com/intl/cms/s/0/3eb9e5cc-f3c3-11e2-942f- 00144feabdc0.html#axzz2ZlHBlKkT

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07/24/2013 11:33 AM Basta 'La Casta' No End in Sight to Italy's Economic Decline By Hans-Jürgen Schlamp The Italian economy may be the third largest in the euro zone, but it is also plagued by inefficiency and continues to shrink. The country's political leadership has proven unable to implement badly needed reforms and the future looks grim. The euphoria was evident. "We've done it!" Italian Prime Minister Enrico Letta tweeted earlier this month after the European Commission had provided his country with new financial leeway. Letta had managed to convince Brussels that Italy would remain below the European Union's budget deficit limit of 3 percent of gross domestic product, if only by a hair, at a forecast 2.9 percent. The premier insisted that his country finally had the latitude to stimulate growth and promote new jobs, and that his administration had achieved "perhaps the most important result" of all time. That was at the beginning of July. Since then, politicians and lobbyists have been energetically arguing over how to take advantage of the new opportunity. Former Prime Minister Silvio Berlusconi wants to abolish the property tax on first homes, which would cost €4 billion. And if the government were to refrain from a planned increase in the value-added tax, as has also been called for, it would forfeit an additional €2 billion ($2.6 billion) in revenues. Letta and the left, for their part, would like to invest €1.5 billion to create new jobs for young unemployed Italians. The debate, and Letta's optimism, has temporarily obscured the difficult situation in which Italy finds itself. All the ideas under discussion for stimulating the country's economy will cost money -- and will require Rome to take on additional debt. Indeed, Standart & Poor's recently showed its lack of faith in the country when it downgraded Italian debt by a notch two weeks ago, a move which infuriated Italians. The truth is that Italy, despite being the third-largest economy in the euro zone after Germany and France, finds itself in dire straits, having been in decline for years. Its GDP has dropped by 7 percent since 2007. The last few years, says Gianni Toniolo, an economics professor in Rome, represent "the worst crisis in (the country's) history," even more devastating that the period between 1929 and 1934. Even More Pessimistic Last fall, the situation looked to be improving, to the point that then Prime Minister Mario Monti promised that "things will improve next year." But those hopes have now faded. The government has reduced its growth expectations for the current year to minus 1.3 percent. The Bank of Italy, the country's central bank, is even more pessimistic, forecasting economic contraction of 1.9 percent. But economic growth only tells part of the story. More than half a million industrial jobs have been lost since 2007, and 15 percent of the country's industrial capacity is gone, says Luca Paolazzi, head of research for Confindustria, Italy's leading industry association. Some sectors have lost even more capacity, with the automobile industry having declined by 40 percent. According to Paolazzi, Italy is experiencing an "unprecedented process of deindustrialization."

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But why? Many products that are made in Italy are still in demand internationally, and not just Armani suits or the Fiat 500. Furthermore, Italy, like Germany, has been able to increase its exports in the last three years. But while exports boosted domestic production in Germany, the same did not happen in Italy. Italian experts attribute this to the growing tendency to produce elements of export goods in Southeast Asia, Poland and Turkey. Many companies merely use plants in Italy to assemble parts made in factories abroad. This is depleting the country's traditional industrial regions. Take, for example, Fabriano, a small city of 30,000 in the Adriatic region known for its "white goods," like refrigerators, ranges and washing machines. Fabriano used to be "a rich community, Italy's Switzerland," says Mayor Giancarlo Sagramola, "until the euro arrived." Weeping and Praying It used to be standard procedure for Italy to devalue its currency, the lira, to offset rising production costs. That, though, is no longer possible resulting in bankruptcy for some companies. Antonio Merloni SpA in Fabriano is one of them; it employed 5,000 people in its heyday. To avoid this fate Indesit, another company based in Fabriano -- whose founders and principal shareholders are from the Merloni family -- shifted some of its production abroad, keeping only 2,900 of 6,500 jobs in Italy. In early June, the company announced plans to slash almost half of those remaining jobs. Those affected by the cuts wept, prayed, wrote petitions and occupied the plant for a few hours. And the mayor knows what the latest bloodletting means for his city: even more unemployment and larger holes in his municipal budget. He doesn't even have the money to repair broken heating systems in municipal buildings, says Sagramola. Indesit employees fear that the recently announced layoffs will quickly be followed by the next step: the discontinuation of production of Italy altogether. But what can protests, tears and prayers do against production and investment conditions that are simply no longer competitive internationally? Wages aren't the problem. They are 15 percent lower than Belgian and French wages and 30 percent lower than wages in Germany, according to a current Bank of Italy comparison. But according to Confindustria, the Italian economy faces a tax burden that is 20 percent higher than in Germany. And unit labor costs are about 30 percent higher than German levels, say central bank officials. The banks, fearful of bankruptcies, are cutting back commercial lending. Even the government isn't paying its bills, with several hundred billion euros in current outstanding financial obligations. It is a dangerous situation, particularly for smaller companies. Ever Deeper Barring fundamental change, the country will go bankrupt, fear economists like Clemens Fuest, president of the Center for European Economic Research (ZEW) in the southwestern German city of Mannheim. The vicious cycle of recession, unemployment and steadily declining purchasing power is driving the Mediterranean country ever deeper into crisis. More than eight million Italians already live below the poverty line, including many who are still employed. The CGIA research institute in Mestre, near Venice, found that

246 one in two small businesses was only able to pay its employees in installments. Three out of five companies are forced to take out loans to pay their high tax bills. The efforts to introduce reform by the so-called government of experts, under economist and former European Commissioner Monti, did little to alleviate the problems. Monti, who took over the country from Silvio Berlusconi in November 2011, proved adept at first aid, succeeded in bringing down dangerously high interest rates on Italian sovereign debt. He likewise pushed through a pension reform that increased the retirement age to 66. Monti also improved government revenues by raising taxes even further. But the country's structural problems remained. They include, in addition to the tax burden, a bloated bureaucracy that obstructs almost all economic activity, an inefficient judiciary that deters potential investors with trials that can last for decades, a relatively low education level and a poor infrastructure characterized by potholed streets, an energy supply prone to failure, constantly delayed trains and outmoded communication networks. As a result, Italy continues to fall behind internationally as a place to invest. It is now 44th in the World Competitiveness Center (WCC) ranking, below the Philippines, Latvia, Russia and Peru, and only slightly above Spain and Portugal. Withdrawing from the Euro? Improving the situation will be no easy task. In a 26-page report commissioned by the Italian president, four "wise men" from Italy's political arena recently listed the needed reforms. But few of their proposals were new. In its country report on Italy, the Organization for Economic Cooperation and Development (OECD) likewise included a large number of suggestions, such as labor market reforms. It also urged the government to reduce spending instead of constantly raising taxes. But it was to no avail. A few days ago, Prime Minister Letta unveiled a thick package of reform proposals. But whether they will ever be implemented is questionable. Nothing is moving, the country is at a standstill, complains Bank of Italy Governor Ignazio Visco. He says the country is "already 25 years behind." Italy's real affliction, though, is politics. "La Casta," as Italians dismissively refer to the leadership in Rome, is partly corrupt, partly ideologically pig-headed and mostly unwilling to compromise. Even the current administration seems incapable of pursuing reform. The only reason the deeply hostile left and right joined forces is that there was no other solution after the elections in the spring. Berlusconi rejects what "the communists" want, and the left feels the same way about Berlusconi. Experts like ZEW President Fuest fear that the situation inevitably means that Italy's debt ratio will continue to rise. Populists like Berlusconi and the founder of the "Five Star" protest movement, Beppe Grillo, are not the only ones advocating the most radical of all solutions for Italy's problems. The country has "a lot of vitality and great potential," says US economist and policy advisor Allen Sinai, but it can only benefit from these strengths "by withdrawing from the euro." Translated from the German by Christopher Sultan

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URL: • http://www.spiegel.de/international/europe/economic-crisis-in-italy-continues-to- worsen-a-912716.html Related SPIEGEL ONLINE links: • Photo Gallery Italy's Decline http://www.spiegel.de/fotostrecke/fotostrecke-99450.html • Debt Paralysis Can Austerity Alone Save Portugal? (07/17/2013) http://www.spiegel.de/international/europe/0,1518,911154,00.html • 'A Toxic System' Why Austerity Still Isn't Working in Greece (07/09/2013) http://www.spiegel.de/international/europe/0,1518,910078,00.html • Downward Spiral Southern Europe Remains Stuck in Crisis (07/03/2013) http://www.spiegel.de/international/europe/0,1518,908856,00.html • Viva la Siesta Should Southern Europe Really Be More German? (06/28/2013) http://www.spiegel.de/international/europe/0,1518,908109,00.html • Ex-Prime Minister Convicted Berlusconi Has One Trick Left (06/24/2013) http://www.spiegel.de/international/europe/0,1518,907633,00.html

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Research-based policy analysis and commentary from leading economists Why economics needs economic history Kevin H O’Rourke, 24 July 2013 The current economic and financial crisis has given rise to a vigorous debate about what training graduate and undergraduate economics students are receiving. This column argues that we don't teach enough economic and financial history, even though it is crucial in thinking about the economy. It also offers a wealth of opportunities for teachers who wish to motivate their students. Related /When is the time for austerity?Alan Taylor/What’s the use of economics?Alan Kirman/How should macroeconomics be taught to undergraduates in the post-crisis era? A concrete proposalWendy Carlin, David Soskice The current economic and financial crisis has given rise to a vigorous debate about the state of economics, and the training which graduate and undergraduates economics students are receiving. Importantly, among those arguing most strongly for a change in the way that young economists are trained are the ultimate employers of these students, in both the private and the public sector. Employers are increasingly complaining that young economists don’t understand how the financial system actually works, and are ill- prepared to think about appropriate policies at a time of crisis. Strikingly, many employers and policymakers are also arguing that knowledge of economic history might be particularly useful.

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• Stephen King, Group Chief Economist at HSBC, argues that: “Too few economists newly arriving in the financial world have any real knowledge of events that, while sometimes in the distant past, may have tremendous relevance for current affairs…The global financial crisis can be more easily interpreted and understood by someone who has prior knowledge about the 1929 crash, the Great Depression and, for that matter, the 1907 crash” (Coyle 2012). • Andrew Haldane, Executive Director for Financial Stability at the Bank of England, has written that “financial history should have caused us to take credit cycles seriously,” and that the disappearance of subfields such as economic and financial history, as well as money, banking and finance, from the core curriculum contributed to the neglect of such factors among policymakers, a mistake that “now needs to be corrected” (Coyle 2012, pp). • In a recent Humanitas Lecture in Oxford, Stan Fischer said that “I think I’ve learned as much from studying the history of central banking as I have from knowing the theory of central banking and I advise all of you who want to be central bankers to read the history books” (2013). The benefits of trying to understand economic history • Knowledge of economic and financial history is crucial in thinking about the economy in several ways. Most obviously, it forces students to recognise that major discontinuities in economic performance and economic policy regimes have occurred many times in the past, and may therefore occur again in the future. These discontinuities have often coincided with economic and financial crises, which therefore cannot be assumed away as theoretically impossible. A historical training would immunise students from the complacency that characterised the “Great Moderation”. Zoom out, and that swan may not seem so black after all. • A second, related point is that economic history teaches students the importance of context. As Robert Solow points out, “the proper choice of a model depends on the institutional context” (Solow 1985, p. 329), and this is also true of the proper choice of policies. Furthermore, the 'right' institution may itself depend on context. History is replete with examples of institutions which developed to solve the problems of one era, but which later became problems in their own right. • Third, economic history is an unapologetically empirical field, exclusively dedicated to understanding the real world. Doing economic history forces students to add to the technical rigor of their programs an extra dimension of rigor: asking whether their explanations for historical events actually fit the facts or not. Which emphatically does not mean cherry-picking selected facts that fit your thesis and ignoring all the ones that don't: the world is a complicated place, and economists should be trained to recognise this. An exposure to economic history leads to an empirical frame of mind, and a willingness to admit that one’s particular theoretical framework may not always work in explaining the real world. These are essential mental habits for young economists wishing to apply their skills in the work environment, and, one hopes, in academia as well.

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• Fourth, economic history is a rich source of informal theorising about the real world, which can help motivate more formal theoretical work later on (Wren-Lewis 2013). Habakkuk (1962) and Abramowitz (1986) are two examples that immediately spring to mind, but there are many others. • Fifth, even once the current economic and financial crisis has passed, the major long run challenges facing the world will still remain. Among these is the question of how to rescue billions of our fellow human beings from poverty that would seem intolerable to those of us living in the OECD. And yet such poverty has been the lot of the vast majority of mankind over the vast majority of history: what is surprising is not the fact that 'they are so poor', but the fact that 'we are so rich'. In order to understand the latter puzzle, we have to turn to the historical record. What gave rise to modern economic growth is the question that prompted the birth of economic history in the first place, and it remains as relevant today as it was in the late nineteenth century. Apart from issues such as the rise of Asia and the relative decline of the West, other long run issues that would benefit from being framed in a long-term perspective include global warming, the future of globalisation, and the question of how rapidly we can expect the technological frontier to advance in the decades ahead. • Sixth, economic theory itself has been emphasising – for well over 20 years now – that path dependence is ubiquitous (David 1985). • Finally, and perhaps most importantly from the perspective of an undergraduate economics instructor, economic history is a great way of convincing undergraduates that the theory they are learning in their micro and macro classes is useful in helping them make sense of the real world. Far from being seen as a 'soft' alternative to theory, economic history should be seen as an essential pedagogical complement. There is nothing as satisfying as seeing undergraduates realise that a little bit of simple theory can help them understand complicated real world phenomena. Think of Obstfeld and Taylor’s use of the Mundell- Fleming trilemma to frame students’ understanding of the history of international capital market integration over the last 150 years; or Ronald Rogowski’s use of Heckscher-Ohlin theory to discuss political cleavages the world around in the late nineteenth century; or the Domar thesis, referred to in Temin (2013), which is a great way to talk to students about what drives diminishing returns to labour. Economic history is replete with such opportunities for instructors trying to motivate their students. References Abramovitz, M (1986), “Catching Up, Forging Ahead, and Falling Behind,” Journal of Economic History 46, 385-406. Coyle, D (2012), What’s the Use of Economics?: Teaching the Dismal Science After the Crisis, London Publishing Partnership. David, P A (1985), "Clio and the Economics of QWERTY." The American Economic Review (Papers and Proceedings) 75, 332-37. Fischer, S (2013), video, quotation begins at 43.48, available online at http://www.youtube.com/watch?v=5Y-ZhFbw2H4.

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Habakkuk, H J (1962), American and British Technology in the Nineteenth Century, Cambridge University Press. Solow, R (1985), “Economic History and Economics,” The American Economic Review 75, 328-31 Temin, P (2013), “The Rise and Fall of Economic History at MIT,” MIT Department of Economics Working Paper 13-11 (June). Wren-Lewis, S (2013), “Economic History and Krugman’s Crib Sheet”.

http://www.voxeu.org/article/why-economics-needs-economic-history

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ft.com World Europe July 23, 2013 6:53 pm Germany’s Free Democratic party breaks ranks with Merkel over tax By Quentin Peel in Berlin Germany’s Free Democratic party, junior partner in the coalition government, has broken ranks with Chancellor Angela Merkel in an effort to revive its electoral fortunes with a pledge to abolish the unpopular “solidarity surcharge” levied to pay for the costs of unification. The move comes after Ms Merkel came out in favour of maintaining the surcharge – an extra 5.5 per cent levied on income tax – after its expiry date in 2019, and extending its use to include projects in poor western as well as eastern towns and cities. More ON THIS STORY/ Global Insight Merkel’s secret is to dull the issues/ Global Insight Small parties pose big threat to Merkel/ Merkel manifesto aims to take middle ground ON THIS TOPIC/ German opposition in minimum pay push/ Global Insight Silence seeks to avert bailout revolt/ Merkel sees off Steinbrück in Bundestag/ German borrowing falls to 40-year low IN EUROPE/ Turkey rate rise highlights dilemma/ Hollande optimism not shared by supporters/ Skopje heritage project proves divisive/ Greek bank chiefs face jail over deaths The issue is a natural one for the FDP, long wedded to reducing the tax burden on citizens and the Mittelstand, the powerful family business sector in Germany. The pledge could prove to be a rare and necessary vote-winner for the party, which faces being wiped out from parliament if it gets less than 5 per cent of the vote. The policy split will not break up the government as although both parties are campaigning to form a repeat of their centre-right coalition, they already have different election platforms. Nonetheless, emphasising the contrast could help them mobilise their respective constituencies, according to political analysts. While Ms Merkel’s Christian Democratic Union supports more social spending, the FDP wants to cut taxes and state spending. Otto Fricke, budget spokesman in the Bundestag for the Free Democrats, said the chancellor was “making an incomprehensible mistake” in wanting to preserve the solidarity levy. Rainer Brüderle, leader of the FDP election campaign, called the surcharge “an alien body in the German tax system”. According to an opinion poll carried out last year for ARD, the public broadcaster, 77 per cent of Germans think the solidarity payment is “no longer in keeping with the times”. The survey by the research group infratest-dimap said there was a clear majority in favour of getting rid of the surcharge in the former East Germany – where the money is supposed to be spent – and in former West Germany. In the west, 83 per cent thought it should be phased out, against 59 per cent in the east.

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In spite of its unpopularity, Ms Merkel spelt out her plan to extend the proceeds of the solidarity levy to poor communities in west Germany as well as in the former communist east, in a weekend interview with Welt am Sonntag, the Sunday newspaper. She said that although it was introduced to pay for the cost of German unification, and revive the collapsed economy of the eastern Länder, or federal states, the surcharge could now help meet the demand for infrastructure investment in both parts of the country. The idea was attacked by Hermann Otto Solms, former deputy chairman of the FDP and finance expert, as a “breach of trust with the electors”. “The citizens have relied firmly on the solidarity surcharge being dropped in a foreseeable timeframe,” he told Handelsblatt, the business newspaper. “The chancellor is breaking her promise.” The surcharge is expected to produce some €13bn in extra tax revenues in the current year, rising to €17.5bn in 2019, at a time when tax revenues are at an all-time high. Three years ago, the constitutional court rejected a taxpayer’s challenge calling for the levy to be scrapped because it should only finance emergency and time-limited expenditure. The latest opinion polls suggest that if the FDP can get its vote back up to more than 6 per cent – still far below the 14 per cent it won in 2009 – Ms Merkel may have a chance to reform her current coalition. According to the latest poll by the Allensbach institute, Germany’s oldest polling organisation, Ms Merkel’s CDU, plus its Bavarian sister party, the Christian Social Union, and the FDP have combined support of 46.5 per cent, against 44 per cent for the parties of the left – the Social Democrats, Greens and far-left Linke party. http://www.ft.com/intl/cms/s/0/cf40f8c6-f3ad-11e2-942f- 00144feabdc0.html#axzz2ZlHBlKkT

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ft.com Markets Capital Markets

July 23, 2013 3:47 pm Banks warn new rules threaten ‘repo’ market By Tracy Alloway in New York

©Reuters Big US banks are warning that new rules on their funding risk damaging the more-than- $7tn “repo market”, where financial institutions borrow against government bonds, potentially destabilising one of the most important financial markets in the world. Analysts at JPMorgan Chase estimate that big banks in Europe, Japan and the US would have to hold at least $180bn of additional regulatory capital to cover their borrowings in the repo market under new leverage ratio rules proposed by US and international banking regulators in recent weeks. More ON THIS STORY/ FT Alphaville Why new leverage ratio rules could stifle repo markets/ Settlement houses in repo collateral deal/ Chinese money rates return to normal levels/ Banks await orders as Fed acts on Basel III ON THIS TOPIC/ US banks reassert market cap dominance/ Wall Street returns to era of big profits/ Smaller US banks could face price war/ Interactive Rebounding banks IN CAPITAL MARKETS/ Abenomics filters through to the CDS market/ US offers mortgage risk to investors/ States and cities to test muni demand/ Motown’s screech will be heard in Europe The market helps fund trillions of dollars worth of securities and financial transactions every day, but it has also come under regulatory scrutiny after a pullback in repo financing helped spur Lehman Brothers’ collapse in 2008. “A [further] retrenchment in repo markets seems inevitable following these rules,” JPMorgan analysts led by Nikolaos Panigirtzoglou said in research published late last week. “This is unwelcome news for the liquidity of the underlying securities.” The leverage ratios proposed by US and international banking regulators require banks to hold a certain level of extra capital against all of their assets, in an effort to cap the financial industry’s borrowing levels in a simpler and blunter way. The ratio proposed by the Basel Committee does not allow banks to “net”, or offset, their various repo trades against one another – making the borrowing more expensive for banks. A similar rule laid out by US regulators earlier this month did not explicitly forbid netting of repos, but referred to the rules proposed by Basel.

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The warnings come as banks prepare to lobby against parts of the new US leverage ratio proposed by local regulators including the Federal Reserve. Executives at two large US banks said that the Treasury department was likely to weigh in on the new leverage rule since it could affect US government debt. The vast majority of repo transactions use government bonds as collateral. “What they’re trying to do with the leverage ratio is to simplify. But I think financing markets in particular will be pretty hard hit under the current framework,” said one repo expert at a large US bank. “Where you could have a real effect is in the higher quality assets like US Treasuries and agency debt. As [the proposed rule is] written today we would definitely have to deleverage our financing business.” A retrenchment in repo would make it the latest bank business to be transformed by new financial rules. Higher capital requirements have already affected banks’ ability to hold corporate bonds, said Brad Hintz, an analyst at AllianceBernstein and a former chief financial officer at Lehman. Big banks’ inventories of corporate bonds have sunk from a 2007 peak of $235bn to $54bn now, partly in response to new rules. “The new leverage rule is going to hit the repo business, securities lending and government bonds, plus any derivatives that are left behind,” Mr Hintz said. But many bank executives have also said they expect the final rule in the US to differ from the one initially proposed. Banks have already begun warning that some aspects of the new rule could affect the wider economy, for example limiting “unfunded credit commitments” which they offer to customers. http://www.ft.com/intl/cms/s/0/ac524eb8-f2eb-11e2-a203- 00144feabdc0.html#axzz2ZlHBlKkT

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Detroit, and the Bankruptcy of America’s Social Contract Author: Robert Reich · July 23rd, 2013 · One way to view Detroit’s bankruptcy — the largest bankruptcy of any American city — is as a failure of political negotiations over how financial sacrifices should be divided among the city’s creditors, city workers, and municipal retirees — requiring a court to decide instead. It could also be seen as the inevitable culmination of decades of union agreements offering unaffordable pension and health benefits to city workers. But there’s a more basic story here, and it’s being replicated across America: Americans are segregating by income more than ever before. Forty years ago, most cities (including Detroit) had a mixture of wealthy, middle-class, and poor residents. Now, each income group tends to lives separately, in its own city — with its own tax bases and philanthropies that support, at one extreme, excellent schools, resplendent parks, rapid-response security, efficient transportation, and other first-rate services; or, at the opposite extreme, terrible schools, dilapidated parks, high crime, and third-rate services. The geo-political divide has become so palpable that being wealthy in America today means not having to come across anyone who isn’t. Detroit is a devastatingly poor, mostly black, increasingly abandoned island in the midst of a sea of comparative affluence that’s mostly white. Its suburbs are among the richest in the nation. Oakland County, for example, is the fourth wealthiest county in the United States, of counties with a million or more residents. Greater Detroit — which includes the suburbs — is among the nation’s top five financial centers, the top four centers of high-technology employment, and the second-biggest source of engineering and architectural talent. Not everyone is wealthy, to be sure, but the median household in the region earns close to $50,000 a year, and unemployment is no higher than the nation’s average. The median household in Birmingham, Michigan, just across the border that delineates the city of Detroit, earned more than $94,000 last year; in nearby Bloomfield Hills — still within the Detroit metropolitan area — the median was more than $150,000. The median household income within the city of Detroit is around $26,000, and unemployment is staggeringly high. One out of 3 residents is in poverty; more than half of all children in the city are impoverished. Between 2000 and 2010, Detroit lost a quarter of its population as the middle-class and whites fled to the suburbs. That left it with depressed property values, abandoned neighborhoods, empty buildings, lousy schools, high crime, and a dramatically-shrinking tax base. More than half of its parks have closed in the last five years. Forty percent of its streetlights don’t work. In other words, much in modern America depends on where you draw boundaries, and who’s inside and who’s outside. Who is included in the social contract? If “Detroit” is defined as the larger metropolitan area that includes its suburbs, “Detroit” has enough money to provide all its residents with adequate if not good public services, without falling into bankruptcy. Politically, it would come down to a question of whether the

256 more affluent areas of this “Detroit” were willing to subsidize the poor inner-city through their tax dollars, and help it rebound. That’s an awkward question that the more affluent areas would probably rather not have to face. In drawing the relevant boundary to include just the poor inner city, and requiring those within that boundary to take care of their compounded problems by themselves, the whiter and more affluent suburbs are off the hook. “Their” city isn’t in trouble. It’s that other one — called “Detroit.” It’s roughly analogous to a Wall Street bank drawing a boundary around its bad assets, selling them off at a fire-sale price, and writing off the loss. Only here we’re dealing with human beings rather than financial capital. And the upcoming fire sale will likely result in even worse municipal services, lousier schools, and more crime for those left behind in the city of Detroit. In an era of widening inequality, this is how wealthier Americans are quietly writing off the poor. This piece is cross-posted from Robert Reich.org with permission. http://www.economonitor.com/blog/2013/07/detroit-and-the-bankruptcy-of-americas- social- contract/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+ec onomonitor%2FOUen+%28EconoMonitor%29

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Daily Morning Newsbriefing July 24, 2013 Detroit - the eurozone connection The Wall Street Journal has a very good story about the effect of the Detroit bankruptcy on European banks. As it turned out, several eurozone banks have large exposure to the city, through complex certificates of participation, which UBS sold in the last decade for $1.4bn, most of which ended up with European banks. The article mentions Hypo-Real Estate, which got stranded with $200m of these CoPs through its Irish subsidiary Depfa, as well as Dexia, which the WSJ says is also holding a large chunk of now essentially worthless paper. The certificates had a maturity of 20 years. The article goes into some depth in the complex technical structure of the certificate, which also includes an embedded interest rate swap. The articles also quotes a municipal bond expert as saying that Detroit would be just the first in a serious of bankruptcy affecting US cities. Meredith Whitney also argues that the aftermath of the Detroit bankruptcy will be shocking, and she also expects a whole range of bankruptcies of other cities. She writes there are five more towns like Detroit in Michigan alone, and many more all over the US. This is an important reminder that the financial crises of 2007 and, of course, the eurozone crises, are not even close to being resolved, as banks are sitting on a lot of debt that was generated in the heydays of the credit boom of the last decade. It looks that we are may be seeing the beginnings of a municipal bond crisis, and as this story indicates, European banks are heavily engaged. Spanish household consumption collapses in 2012 Spain's National Statistics Institute INE released its 2012 survey on household budgets. Mean household expenditure was just above €28k for the year, 3.4% lower than in 2011. This is half of the drop since the first year the survey was conducted (-6.8% since 2006) which was just before the crisis. The mean expenditure per person was €11k in 2012, a drop of 2.4% from a year earlier. In relative terms, the largest one-year drops in expenditure were in new vehicles (-20%) with clothing a distant second at -10%. The largest increases since 2011 were in transportation (+7.1%) and energy (electricity, gas and fuels, +3.7%). Since 2006, the largest drops were a whooping -62% again on new vehicles and -33% on clothing, while the biggest increases were in energy (+50%) and 'real' rent (+47%). In its coverage of the release, El País chose to highlight a peculiar but perhaps illustrative statistic: pocket money for minors dropped by 38% to €9 per family between 2008 and 2012. Letta to press ahead with party funding reforms Enrico Letta said he would press ahead with a bill to abolish public funding for political parties, as Il Corriere della Sera reports. If the bill is approved, party funding would be reduced to 60% of its current level in the first year, to 50% in the second year and to

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40% in the third year before being abolished altogether. But the bill is facing a difficult passage through Parliament after over 150 amendments were presented to it, a typical Italian delaying tactic. The Movimento 5 Stelle continues to ask for full abolition, but PD and PdL have rules this out. As the bill stands, the money would be divided proportionally among all parties, with most of it going to the PD and PdL. The government, meanwhile, will face another confidence vote today, about government legislation to free up €3bn in public works projects – for which parliament tabled 800 amendments. The confidence vote will take place at 11:30 CET Italy will face a net loss of 250,000 jobs in the private sector in 2013 Italy will suffer a net loss of 250,000 jobs in the private sector this year, La Repubblica reports. According to the association of Italian chambers of commerce Unioncamere, there will be 750,000 new hires in 2013 in the industry and service sectors, but almost one million people will leave the labour market due to redundancies, dismissals and retirements. Unioncamere said that the level of new recruitment should be 112,000 lower than in 2012. Labour Minister Enrico Giovannini said that despite the crisis, companies were trying to keep their workers. The Italian industrial lobby Confindustria has called again for a cut in labour taxes to encourage firms to hire workers. But the government is currently focusing on the abolition of real-estate taxes and VAT. Berlusconi to relaunch Forza Italia in September Silvio Berlusconi is preparing for the next elections, Il Sole 24 Ore reports. In a statement via Facebook, Berlusconi wrote that the PdL will soon be revamped and relaunched as Forza Italia, the original name of him party in 1994. According to Berlusconi, the PdL has decided to go back to Forza Italia because, the party wants to attract young people, especially the upwardly mobile young . Berlusconi also said the change will take effect in September. The decision, as the paper says, has arrived because several polls showed the old brand Forza Italia had more appeal to voters than the PdL, which lost millions of supporters in the latest elections. Germany delays decision on next aid tranche for Greece to Monday Germany will postpone signing off on the disbursement of Greece's next €2.5bn tranche of bailout aid until next Monday to ensure conditions are met. According to a letter sent by Deputy Finance Minister Steffen Kampeter on Tuesday and seen by Reuters, the European Commission is still awaiting confirmation Greece has completed all measures required. Only 17 of 22 "prior actions" stipulated by international lenders have so far been confirmed as completed, Kampeter wrote, insufficient to receive the approval of Germany's budget parliamentary committee which is key for Berlin's green light. Kampeter wrote that he expected a review of Greece's progress to be updated on Wednesday and then sent to the German Bundestag lower house of parliament. "To give the budget committee sufficient chance to form an opinion on this, the original deadline will be lengthened to Monday, July 29," his letter reads. It had originally been planned for Wednesday, July 24. Greece to push another 5500 civil servants into “mobility scheme” One of the prior actions that still needs to be completed is to meet the first target of 12500 public sector workers to be placed in a mobility scheme by September, Kathimerini reports. The government is still short by 5500 public sector workers to be placed in the mobility scheme, hoping to find them when it completes the new

259 organizational charts for ministries and the merging of public organizations. Up to 1300 will come from the restructuring of public healthcare. Up to 1000 more are due to come from the Defence Ministry, while some 1000 administrative employees out of a total of 10200 in the tertiary education sector could also be transferred. Education Minister Constantinos Arvanitopoulos insisted that no more educators could be transferred as it would put the whole sector at risk. After September, the government has to find another 12500 to enter the programme by the end of the year, and 4000 civil servants will have to be fired. Coelho’s new cabinet to be sworn in today Portugal's president approved on Tuesday the promotion of the new cabinet with CDS- PP leader Paulo Portas as deputy prime minister and a wider government reshuffle, in a move that gives the junior partner more power over economic policy. The big surprise for Jornal de Negocios was the nomination of Rui Machete, 73, a lawyer specialized in public law, who had served as deputy prime minister in an earlier PSD government. Also new but less surprising is the nomination of Antonio Pires de Lima, an economist and politician from Portas' CDS-PP party. A new ministerial post, for environment, territorial management and energy was created and given to environmental expert Jorge Moreira da Silva, from Coelho’s PSD party. The new cabinet will be sworn in today. French minister tells Socialists pension reform will be “ambitious enough” French Social Affairs Minister Marisol Touraine told Socialist lawmakers on Tuesday the government would push ahead with plans to lengthen the mandatory pension contribution period, Reuters reports, a contentious issue that the party opposes. Hollande wants to accelerate a process already under way to extend the mandatory pension contribution period beyond the current 41.5 years, a plan that has created tensions with unions threatening street protests and strikes. In a meeting with Socialist deputies on Tuesday, Touraine said she wanted an "ambitious enough" reform, rejecting any notion the government would postpone. Without reform, the funding gap in France's pension system, depleted by rising unemployment, is expected to rise from today's €14bn to €20bn by 2020. The European Commission has urged France to balance the system's books no later than 2020 and the European Union has granted the country two extra years to bring its overall budget deficit into line. German institute blasts opposition tax plans The Berlin-based DIW economics institute has calculated that the plans by SPD and the Greens to raise income tax for higher income earners are unlikely to bring in more revenues. The parties both propose an increase in the top income tax rate from 42% to 49%, albeit in different steps. According to DIW, between 6 and 7% of households would face higher bills. The study calculates a headline total of €6.5bn in extra revenues from the SPD plans, but the number is going to be lower in reality, as high income earners have legal means to avoid taxes, which could reduce the total tax take by between 30 and 50%. Eurobarometer: majority expecting the worst still to come The latest Spring Eurobarometer showed became slightly more optimistic compared to the last survey in autumn: 36% of people surveyed thought the job crisis had reached its peak (up 6pp), while 55% expect further turmoil ahead (down 7pp), Despite the EU

260 crisis, 62% of respondents said they still identified themselves as EU citizens. But less than half of Greeks and Cypriots felt like they were a part of the bloc. An absolute majority (51%) of Europeans are in favour of the euro, with those living within the Euro area supporting the single currency with a two-thirds majority (62%). Overall support for the euro is down only marginally from 56% in 2006. People from Slovenia, Slovakia and Luxembourg were the biggest euro fans, with 77% of citizens from each country in favour of the single currency. Support in Germany was 66%, in Greece 60%, while only 52% in Portugal and Spain. A closer look by KT Greece shows a much more sinister picture for Greece compared to the EU average, though figures have improved even there. 68% of Greeks believe that the worst is still to come (down 10pp). 68% of Greeks (slight improvement of 2% over the previous Eurobarometer) and 35% of EU citizens say the current situation does not allow them to make plans for the future and live day to day (worsening 7%). Overall, the image of the EU deteriorated badly: from 50% positive and 15% negative in Spring 2006, to a virtual tie at 30% in 2013. 'Neutral' feelings have increased from 1/3 to 2/5 in the same period. The outlook on the EU has also deteriorated, from 69% optimistic over 24% pessimistic in the Spring of 2007 to a virtual tie at 49% to 46% in 2013; by far the most pessimistic countries are Greece, Cyprus and Portugal, all around 30% optimistic to two thirds pessimistic, followed by Spain at 40% to 50%. No deal yet between FASB and IASB on loan provisions Reuters has the story that the world’s two most important accounting bodies, the International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB) are no closer to an agreement on the treatment on loan provisions. In 2009, the G20 called for common standards, a call reiterated last week with a deadline of end-2013 for an agreement. The two bodies met on Tuesday, but did not get anywhere, Reuters reports. The issue is that the FASB wants banks to make provisions as soon as a loan is issued – based on credit rating, collateral quality, and macroeconomic indicators. The IASB only wants a portion of losses provisioned from the outset. The FASB says the IASB model would lead to a fall in reserves by 15% in the US. The article says that even if a deal is reached by December, it will possibly take three years to take effect. Kevin O’Rourke is really angry Writing in the Irish economy blog Kevin O’Rourke asks, rhetorically, what will it take for the EU to admit that policy is not working? Unemployment clearly is not an issue, nor is the recession. But what about debt-to-GDP, which is the EU’s self-imposed metric of the crisis? “This is where dodgy GDP forecasting becomes so pernicious: no matter how much of a basket case the Eurozone becomes, over-optimistic forecasts — notice how good we expect 2014 will be!! — will always make it possible for discredited politicians, central bankers and eurocrats to cling on to the hope that good times are just around the corner. The risk is that they will wake up one day and find that it is too late to change course, both for themselves and for the euro.” Frankel on Europe’s flawed recession metric With a hat tip to Kevin O’Rourke, this is from Jeff Frankel, who writes that the US method of defining recession – through an NBER committee that looks at the business cycle - is much superior to the European obsession with two consecutive falls in GDP

261 growth. In Europe, commentators endless discuss double-dip recessions, while the reality is that this is all the same recession all along. He quotes several examples, including Ireland, where the assessment would be completely different if NBER criteria were applied. He writes that Irish GDP has not yet recovered more than half of what it lost between late 2007 and the bottom in 2009. If US methods had been applied, the end of the recession would not have been declared. As a result there would be no talk of a double-dip. Other examples he cites are Finland and Italy. Italy’s GDP is now 8% below its level in 2008. Here he explains, why this difference between the two approaches, matters: “There is also a potentially more far-reaching and serious disadvantage. Citizens in Ireland and Italy have been given the impression that they have entered new recessions. Voters are likely to draw the conclusion that their political leaders must have done something wrong recently. More likely, these countries have been in the same recession for five years. The implication may be that the leaders have been doing the same wrong things throughout that period. It’s not an unimportant difference.” Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.680 0.662 0.648 Italy 2.807 2.791 2.775 Spain 3.068 3.103 3.067 Portugal 4.881 4.918 4.956 Greece 8.741 8.729 8.75 Ireland 2.310 2.284 2.269 Belgium 1.029 0.984 0.967 Bund Yield 1.516 1.552 1.568 Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.318 1.3213

Yen 131.490 131.84

Pound 0.859 0.8591

Swiss Franc 1.237 1.237

ZC Inflation Swaps

previous last close

1 yr 1.47 1.55

2 yr 1.39 1.48

5 yr 1.5 1.6

10 yr 1.84 1.95

Euribor-OIS Spread

previous last close

1 Week -6.557 -6.557

1 Month -3.029 -5.029

3 Months 1.029 1.129

1 Year 29.829 28.829

Source: Reuters

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Jeff Frankels Weblog Views on the Economy and the World One Recession or Many? Double-Dip Downturns in Europe Jul 22nd, 2013 by jfrankel | The recent release of a revised set of GDP statistics by Britain’s Office for National Statistics showed that growth had not quite, as previously thought, been negative for two consecutive quarters in the winter of 2011-12. The point, as it was reported, was that a UK recession (a second dip after the Great Recession of 2008-09) was now erased from the history books — and that the Conservative government would take a bit of satisfaction from this fact. But it should not. Similarly, in April of this year, Britain was reported to have narrowly escaped a second quarter of negative growth, and thereby escaped a triple dip recession. But it could have saved itself the angst. The right question is not whether there have been double or triple dips; the question is whether it has been the same one big recession all along. As the British know all too well, their economy since the low-point of mid-2009 has not yet climbed even halfway out of the hole that it fell into in 2008: GDP (Gross Domestic Product, which is aggregate national output) is still almost 4% below its previous peak, as the first graph shows. If the criteria for determining recessions in European countries were similar to those used in the United States, the Great Recession would probably not have been declared over in 2009 in the first place.

Recent reports that Ireland entered a new recession in early 2013 would also read differently if American criteria were applied. Irish GDP since 2009 has not yet recovered more than half of the ground it lost between the peak of late-2007 and the 263 bottom two years later. Following US methods, the end would not yet have been declared to the initial big recession in Ireland. As it is, a sequence of tentative mini- recoveries have been heralded, only to give way to “double-dips.” Similarly, it was recently reported that Finland had entered its third recession since the global financial crisis. But the second recession (two negative quarters that were reported for 2009 Q4 and 2010 Q1) would be better described as a continuation of the first. Worse, Italy under U.S. standards would clearly be treated as having been in the same horrific five-year recession ever since the shock of the global financial crisis: the recovery in 2010-11 was so tepid that the level of Italian economic output had barely risen one-third the way off the floor, before a new downturn set in during 2012. And the two downturns have been severe: Italy’s GDP is now about 8% below the level of 2008, as the graph shows. (In general, the preceding peak is not always the right benchmark. On the one hand, that level of GDP may set too high a bar if it was above potential output, as in the particular case of the housing bubbles of the last decade. On the other hand, the preceding peak may be too low a benchmark because potential output has risen during the intervening months, especially in the case of developing countries with rapid trend growth in the labor force or productivity.)

These issues sound like minor technical details. But they are not necessarily without real importance. First, what is the difference in criteria, anyway? Economists in general define a recession as a period of declining economic activity. European countries, like most, use a simple rule of thumb: a recession is defined as two consecutive quarters of falling GDP. In the United States, the arbiter of when recessions begin and end is the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER). The NBER Committee does not use that rule of thumb, nor any other 264 quantifiable rule, when it declares the peaks and troughs of the US economy. When it makes its judgments it looks beyond the most recently reported GDP numbers to include also employment and a variety other indicators, in part because output measures are subject to errors and revisions. Furthermore the Committee sees nothing special in the criterion of two consecutive quarters. For example, it generally would say that a recession had taken place if the economy had fallen very sharply in two quarters, even if there had been one intermediate quarter of weak growth in between the other two quarters. Further, if a trough is subsequently followed by several quarters of positive growth the NBER Committee does not necessarily announce that the recession has ended, until the economy has recovered sufficiently well that a hypothetical future downturn would count as a new recession instead of a continuation of the first one. Fortunately, the US economy has had positive economic growth for the last fifteen consecutive quarters, by any measure, so these issues are not currently active on our side of the Atlantic. But things are not always so quiet. The US economy contracted three quarters in a row in 2001, for example, measured with the revised GDP statistics that are available today. But at the time when the NBER committee declared that there had been a recession in 2001 (based on employment and various other indicators), the official GDP statistics did not show two consecutive quarters of declining output, let alone three. That episode is a good illustration of the benefits of a broader approach to the task of declaring business cycle turning points. The NBER Committee has never yet found it necessary revise a date, let alone erase a recession, once declared. Although the focus on a two-quarter rule and on currently-reported GDP statistics is common in the rest of the world, the NBER is not the only institution that looks beyond it. An analogous Euro Area Business Cycle Dating Committee was set up ten years ago by the Center for Economic Policy Research in London. This committee declared that the Great Recession ended in the euro area after the 2nd quarter of 2009, the same time as in the US. It also declared that a new second recession started in the latter part of 2011 — a recession that Europe is still in. These were probably the right judgments: growth in the quarters in between the two slump intervals was sufficiently strong in some countries such as Germany so that economic activity on average across the eurozone had by mid-2011 re-attained about 2/3 of the ground that it had lost in 2008- 09. Hence two separate European recessions instead of one very long one. The CEPR committee passes judgment only on the euro economy as a unit, not for individual countries within it, nor for countries like the United Kingdom that are outside the euro. They remain subject to the statistical vagaries of evanescent GDP revisions. One cannot say that the two-quarter rule of thumb used by individual countries in Europe and elsewhere is “wrong.” There are unquestionably big advantages in having an automatic procedure that is simple and transparent, especially if the alternative is delegating the job to a committee of unelected unaccountable ivory-tower economists. The press statements of the NBER Committee tend not to be greeted appreciatively. Many critics express puzzlement each time at the need for a secretive committee, relative to an objective two-quarter rule. (Other critics each time complain that the committee has only said “what everybody has known for a long while”. Some critics have managed both complaints at the same time, even when the two-quarter rule would not have given the answer that “everybody knows.”) But there are also disadvantages to the rule of thumb. One disadvantage is the need to get out the white-out when the statistics are revised, as Britain is now doing with its vanished recession of 2011-12. Claims that last year appeared in the speeches of UK

265 politicians and in the writings of researchers, made in good faith at the time, have now been rendered false. Similarly, France in May of this year revised away an earlier recession, which would otherwise have been counted as the second since 2008. But it has now reported a new and different second recession, based on the latest statistics for last winter: miniscule declines of 0.2% of GDP in Q4 of 2012 and Q1 of 2013, which should really be considered insignificant. There is also a potentially more far-reaching and serious disadvantage. Citizens in Ireland and Italy have been given the impression that they have entered new recessions. Voters are likely to draw the conclusion that their political leaders must have done something wrong recently. More likely, these countries have been in the same recession for five years. The implication may be that the leaders have been doing the same wrong things throughout that period. It’s not an unimportant difference. [I would like to acknowledge the assistance of Ayako Saiki. This blogpost is an extended version of a Project Syndicate column. Comments can be posted at that site.] http://content.ksg.harvard.edu/blog/jeff_frankels_weblog/2013/07/22/one- recession-or-many-double-dip-downturns-in-europe/

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ft.com Comment Opinion July 23, 2013 7:33 pm Detroit aftershocks will be staggering By Meredith Whitney Leaders across the country cannot continue as they have, says Meredith Whitney

©Bloomberg As jarring as the reality may be to accept, Detroit’s decision last week to declare bankruptcy should not be regarded as a one-off in the US municipal market – which is what the bond-peddlers are now telling their clients. The aftershocks of the largest municipal bankruptcy in US history will be staggering, and Detroit will set important precedents. Municipal bankruptcies have historically been rare for a number of reasons – including the states’ determination to preserve their credit ratings, their access to cheap funding and the stigma of bankruptcy. But, these days, things are very different in the world of municipal finance. More ON THIS STORY/ Detroit unease throws up muni opportunity/ Lunch with the FT Meredith Whitney/ Detroit bankruptcy risks upping costs of other states/ Lex Detroit – nuanced answers/ Editorial Bankrupt Detroit ON THIS TOPIC/ States and cities to test muni demand/ City of Detroit files for bankruptcy/ Moody’s warns on $980bn pension gap/ Illinois tests muni market with offering IN OPINION/ Petina Gappah Opposition shuns chance to unseat Mugabe/ Adam Posen US should support trade deal with Japan/ John McDermott Help to Buy and ‘subprime’/ Ian Bremmer and David Petraeus Abe’s win is great news At the root of the problem is the incentive system that elected officials used to face. For decades, across the US, local leaders ran up tabs for future taxpayers; they promised pensions and other benefits for public employees that have strong legal protection. That has been a great source of patronage for elected officials: they can promise all sorts of future perks to loyal supporters (state and local workers) with very little accountability on the delivery of those promises. Today, we are left with the legacies of this waste. The bill for promises past is now so large for some cities and towns that it is crowding out money for the most basic of services – in the case of Detroit, it could not even afford to run its traffic lights. Across many American cities, cuts to basic social services have already been so deep that they have made the communities unpleasant places. This is, in part, because of a strange legal position. Over the past decade, US states’ finances have run deficits in more years than they have not. But, of the 50 states, 49 are constitutionally required to balance their budgets; quick cuts to social services were largely used to bridge the gaps. This meant delays in infrastructure projects,

267 delays in basic maintenance of roads, bridges, and schools, cuts to school and higher education. This type of cut is allowed by state constitutions. But, under the same laws, cuts to pension and benefit costs or debt service payments are often not permitted. In other words, education and public safety tend not to be safeguarded by constitutions but pensions and repayments on municipal bonds are. So, over the past several years, basic social services have steadily eroded, and in most cases home values have declined, crime rates have soared and education has suffered. Rotten public services take a toll on home values and business investment alike. After all, what makes one neighbourhood worth more than another is the perceived value advantage of its schools, safety, public parks and libraries. Cuts in services happen even when taxes go up; the combination acts to drive out businesses and other taxpayers from the area. This sets off the negative feedback loop from hell. So leaders across the country cannot continue as they have. They must choose sides because there is simply not enough money to go around. Will they side with taxpayers, unions or the municipal bondholders? If they back residents, money will be directed to underfunded public services at the expense of pensions and bondholders. If they side with the unions, social services will continue to be cut and the risk to bondholders will increase considerably. If they side with bondholders, social services and pensions are at risk. Up to this point, it has taken either an incredibly daring elected official to stand up for taxpayers or, in the case of Detroit, an appointed official (read “unelected”) whose mandate has been the “emergency management” of the city. After decades of near-third- world conditions in the richest country in the world, the city finally stood up and said enough was enough. Officials could raise taxes further and cut social services deeper but leaders are finding these once “go-to” measures to be counterproductive. They are destructive to the very sustainability of the city. Since the credit crisis, taxpayers have paid most dearly in terms of reduced social services while paying the same or often higher tax bills. Increasingly, unions are being asked to make concessions on pensions and benefits. And – now – bondholders, who up until last week thought they would be protected in almost any scenario, are being forced to make a contribution to the fiscal problem. Elected officials, for the first time in a very long time, are siding with residents. This is a new precedent that boils down to the straightforward reality of the survival and sustainability of a town or city. There are five more towns like Detroit in Michigan alone. There are many more municipalities across the country in similar positions. Detroit’s decision last week paves the way for other elected or non-elected officials to make decisions to save their cities and towns, decisions that probably involve politically unpopular actions that may secure their long-term viability. The writer is author of ‘Fate of the States’ http://www.ft.com/intl/cms/s/0/34abcabc-f389-11e2-942f- 00144feabdc0.html#axzz2ZiNqtThN

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The Irish Economy

What would it take to make the EU admit the strategy isn’t working? This post was written by Kevin O’Rourke We know that rising unemployment is not something that will make the EU admit that their current macroeconomic policy mix isn’t working. We know that two successive years of GDP contraction is not something that will make them admit it either. Even though some of them denied at the time that this could be a consequence of austerity. Will spiralling debt/GDP ratios do the trick? This is, after all, the number they have been fixated on since 2010, and the figures show that, even on its own terms, the current strategy has not been working. This is where dodgy GDP forecasting becomes so pernicious: no matter how much of a basket case the Eurozone becomes, over-optimistic forecasts — notice how good we expect 2014 will be!! — will always make it possible for discredited politicians, central bankers and eurocrats to cling on to the hope that good times are just around the corner. The risk is that they will wake up one day and find that it is too late to change course, both for themselves and for the euro. This entry was posted on Tuesday, July 23rd, 2013 at 7:41 am and is filed under EMU. Kevin O’Rourke http://www.irisheconomy.ie/index.php/2013/07/23/what-would-it- take-to-make-the-eu-admit-the-strategy-isnt-working/

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Daily Morning Newsbriefing July 23, 2013 Letta government near a deal on IMU Enrico Letta’s government is close to reaching an agreement to scrap the IMU property tax, La Stampa reports. As asked by Silvio Berlusconi as fundamental conditions for the survival of current government, the unpopular IMU will be revised. According to the regional affairs minister Graziano Delrio, one of the prominent PD members, IMU will be abolished on all primary residences, except for luxury homes. Delrio said it will also stay in place on holiday homes and other properties that are not the owners’ main residence. According to Delrio, the main question about the IMU now was not whether it would be scrapped, but whether it would abolished this year or next. The government needs to find over €4bn to cover the financial gap if IMU will be abolished. Fabrizio Saccomanni has said it will be difficult to scrap IMU and hit other policy targets, such as preventing a 1% rise in the top band of VAT scheduled for later this year. Meanwhile, the Italian government has almost €15.7bn available for paying off its outstanding bills to private companies, according to Saccomanni. As Il Corriere della Sera reports, Saccomanni confirms that the debt repayment is ongoing and he hopes that by September he will outline a complete plan for reaching the amount of €20bn committed for the current year. According to the Treasury, the data will be updated every two weeks. In April the Italian government has pledged to payback €40bn over this year and next to boost private firms’ competitiveness. Payments of more debt owed to Italian companies may even be possible earlier than expected, added Saccomanni, but it is not clear how. According to Treasury sources, it would be possible after some securitisations later this year. Italian new mortgages suffer a 10% drop As Il Sole 24 Ore reports, applications for new home mortgages dropped by 10% in the first half of this year compared with the same period of 2012, according to data released by business ratings agency CRIF. The figures showed that consumers are worried by a possible rise in borrowing costs and prefer to look for fixed interest rates, in contrast with the past. CRIF said that fixed-rate mortgages rose to a market share of 18% in the second quarter of this year from 12% in Q2 of 2012, due to more aggressive pricing policies of the majority of Italian banks and new taxes. Meanwhile, CRIF noted that house prices are continuing to fall. In the first quarter of 2013, the average price running about €115,712 compared with about €120,000 marked in the same period last year. The average price could reach the low level of €100,000 in the second part of the year due the postponement of VAT increase and the suspension of the IMU tax that could erode savings of Italian families reducing home transactions. Coelho to announce his “new” government today The Portuguese president may have calmed down the markets by keeping the government in place until 2015, but the tensions over austerity are still unresolved. Reuters reports that year bonds fell about 33bp to 6.59%.

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Passos Coelho will present his “new” government today, as reported by Diario Economico, and will have to lay out the new government programme before the vote of confidence can go through in the next 7 days, according to Jornal de Negocios. The premier on Monday confirmed his plan is still to make Paulo Portas his vice-president and put him in charge of negotiations, although he yet needs to formalise the request to the president who will then announce the final terms of the reshuffle. If the cabinet shakeup goes ahead, it remains to be seen how Portas will deal with a finance minister whose appointment he criticised and how he is putting a “firm” stance with the lenders into practice. It also seems unlikely that the austerity programme remains as it is. Jornal de Negocios writes that Passos Coelho hinted that he might replace contentious measures which did not yet pass in parliament with new measures. Employers organisation and trade unions unison reject the current programme arguing that economic recovery is unlikely to happen if the budget cuts are implemented. They will use their new standing in the social dialogue as requested by the president. The events so far have done little to steer Portugal away from the potential of having to request a second bailout, which some fear could imply losses for private debt holders. Rajoy to speak in parliament On Monday evening the Spanish government filed a request for Mariano Rajoy to speak before the Parliament "on the political and economic situation" reports EFE. This is interpreted as meeting opposition demands for Rajoy to address the scandalous allegations in the Bárcenas case, though Rajoy himself and speakers for the government or the People's Party studiously avoid mentioning it explicitly. In the morning, Rajoy had participated in a "news breakfast" with the regional Premier of the Balearic Islands, José Ramón Bauzá, who stuck to the recent PP line that Rajoy would address the nation "when he sees it fit". El País writes that Rajoy left the event shortly after Bauza's prepared remarks and before the start of the panel discussion, so as to avoid questions from the press. Mariano Rajoy could not avoid the press in the afternoon, when he had a joint press conference with Romanian PM Victor Ponta. On this occasion it was Romanian journalist Ciprian Baltoiu to ask Rajoy in Spanish "when and how" he was going to address the allegations from the Bárcenas case, reports El País. Caught by surprise, Rajoy said he had talked with the Speaker of the Spanish Lower House, Jesús Posada, about his intention to speak before the Parliament "on the political and economic situation" some time before the summer recess. El País writes that the Romanian journalist told his Spanish colleagues that he intended to "lend a hand after last week", in a reference to allegations that Rajoy and ABC rigged the Spanish half of the press questions during his joint press conference with Poland's Donald Tusk last Monday. Spain's SAREB to sell a further €600m to wholesale investors Two weeks ago we reported from Cinco Días that Spain's bad bank SAREB was undertaing two wholesale asset sales codenamed 'Bermudas' and 'Bull' with notional values of €1.2bn and €200m respectively. Cinco Días explained that over one thirds of the SAREB's portfolio is made of financial assets and that sales to institutional investors are perhaps more important to the SAREB than retail market sales.

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Now, El Confidencial writes that the SAREB is launching two more wholesale asset sales, codenamed 'Teide' (€150m) and 'Corona' (€450m). The paper enumerates a short list of investment funds which are known to have bid on the smallest of the deals, 'Operation Bull'. The asset sales are being structured through vehicles know as FAB (Banking Asset Funds), which are essentially a separate legal category for securitization SPVs originated by the SAREB. According to El Confidencial, this legal structure is annoying the prospective investors as the FABs must be serviced by dedicated asset management trusts which tend to be owned by the banks whose bad assets ended up in the SAREB. The crippling costs of Spain's handpicked advisers Using figures from the general audit office of the public administration, El Economista concludes that after three years of public servants' wage cuts and freezes, the public sector's wage bill has only shrunk by 2.1% because the salaries paid on temporary contracts and high advisors to political appointees has grown by 9,5% in the last year. Eurozone debt to GDP from 90.6% at 92% in Q1 Spiegel Online reports on the latest Eurostat release according to which debt-to-GDP has risen from 90.6% in Q4 2012 to 92.2% in Q1 2013. In Greece, the debt-to-GDP has risen from 157% to 160% during Q1 – close to the 174% mark before the debt restructuring. Ranked next comes Italy with a debt-to-GDP ratio of 30%, Portugal 127%, and Ireland 125%. Germany’s ratio fell from 81.9% to 81.2%. Il Sole 24 Ore noted about the Italian number that this constituted a full derailment from the Treasury forecasts. The reasons are the fall in GDP and the increase in ESM tranche payments. The paper said the government should focus on debt reduction through measures such as a full implementation of Saccomanni’s plan to sell State properties in the next five years. EU companies switch to corporate bonds The FT has a report according to which European companies are set to reduce borrowing from the syndicated loan markets to below €500bn, the first time this happened in a decade. So far this year, the proportion of syndicated debt financing has fallen to below 50%, down from 60% last year, according to Fitch. These data would corroborate the theory that European companies are using the crisis to move to a US style bond market. In the US, bond funding constitutes two thirds of total funding, while in Europe the proportion has been traditionally around one third. Another reason for this trend is the fall of average borrowing costs on European investment grade corporate bonds, which are down from 2.8% last summer to 1.8% last month, according to Barclays. Strong GDP growth in Q2, but expansion now slowing Frankfurter Allgemeine has a good analytical news stories on the latest economic data in Germany, which are pointing to a strong, but temporary rise in GDP during Q2. Yesterday, the finance ministry reported on a 4.3% increase in tax revenues in June relative to June 2012. The article cites forecasts from two economic institutes according to which the economy has expanded by 0.9% during Q2, but but this is in part to due the cold weather in Q4, which has pushed some activity into Q2. The consensus among German forecasters is that the economy will continue to expand for the rest of the year, but at a reduced rate.

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IMF refutes Mody The IMF has distanced itself from comments made by its former Ireland mission chief that austerity was self defeating, on which we reported yesterday, the Irish Independent reports. Ashoka Mody said that the Irish government should consider suspending or at least lowering its planned €3.1bn adjustment for October’s budget. But the IMF said there was no evidence that the government’s plan had been self defeating. The deficit fell steadily. “There has been an unavoidable drag on Ireland's growth, but other factors have also weighed on growth, including the notably worse external environment and the efforts of the private sector to reduce its high debts.” Mody told RTE Radio’s This Week programme yesterday that moving away from austerity at this point was a sensible course of action. Sinn vs Ferguson Hans-Werner Sinn has a riposte to Niall Ferguson in the FT, in which Sinn suggests “muddling through” as the only solution to the crisis. By “muddling through” he means that Germany accepts higher inflation, while the southern countries reduce theirs. This process requires austerity. Countries that cannot cope, such as Greece, should be allowed to leave, and readmitted later. An exit should be accompanied by haircuts that convert debt into national currencies. There may also be debt moratoriums for countries that choose to stay inside the eurozone. He concludes his argument with a reference to US history. The US also has no bail-out clauses for its states. Since the eurozone will never be as integrated as the US, there is no case for the mutualisation of debt. We agree that Hans Werner Sinn’s version of muddling through may work, but note that his use of the term “muddling through” is clearly different from those of many EU officials, for whom the term has a rather different connotation. The outcome that a country could leave the eurozone is precisely what in their view “muddling through” should avoid. Sinn is advocating a resolution of the crisis, through a combination of exit, default, and adjustment, while the supporters of “muddling through” are generally not prioritising crisis resolution. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.671 0.680 0.668 Italy 2.894 2.775 2.776 Spain 3.125 3.068 3.037 Portugal 5.336 4.881 4.871 Greece 8.738 8.741 8.77 Ireland 2.329 2.310 2.314 Belgium 0.997 1.029 1.020 Bund Yield 1.52 1.516 1.515 Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.316 1.3189

Yen 131.590 131.19

Pound 0.861 0.8584

Swiss Franc 1.236 1.2347

ZC Inflation Swaps

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previous last close

1 yr 1.47 1.47

2 yr 1.39 1.39

5 yr 1.5 1.5

10 yr 1.84 1.84

Euribor-OIS Spread

previous last close

1 Week -5.414 -6.014

1 Month -3.586 -2.986

3 Months 3.300 3

1 Year 30.129 30.029

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-07- 23.html?cHash=46633d6c65eb54fb5adc1a3200157c55

07/23/2013 12:43 PM Rajoy's Successor? The Most Powerful Woman in Spanish Politics By Helene Zuber As illegal party financing allegations close in around Spanish Prime Minister Mariano Rajoy, his 42-year-old deputy has kept her name clean. Now Soraya Sáenz de Santamaría, the most powerful woman in Spanish politics, is well poised to be his successor. "Bring your own chorizos," read the invitation. Thousands showed up, assembling outside the headquarters of Spain's ruling People's Party in downtown Madrid for a symbolic barbecue. Similar gatherings took place in front of the party's offices in 30 other Spanish towns. Chorizo is both the name of the thick, spicy sausage popular in Spain, and a word used to describe corrupt politicians. The protests came in response to double accounting conducted by the party's former treasurer, Luis Bárcenas. His incriminating ledgers, uncovered by Spanish newspapers, also implicate Prime Minister Mariano Rajoy, as well as the party's secretary-general, other former ministers in the People's Party and further prominent conservative politicians. The only one who doesn't make an appearance in Bárcenas' accounts is Spain's most powerful female politician, Soraya Sáenz de Santamaría, the 42-year-old deputy and closest confidante of the prime minister. As Rajoy becomes increasingly mired in the massive scandal over illegal party donations, corruption and financial contributions, Sáenz de Santamaría, a former state lawyer who represented the country's highest court, is one of the few in the party to remain untouched by the allegations. And that alone may be enough to qualify her for the government's top job. Calls for Resignation The prime minister, meanwhile, is having to answer some uncomfortable questions: Why, for example, he continued to pay his party's former treasurer a monthly salary of

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€21,300 ($28,100), even though Bárcenas was forced to resign from his position three years ago after first being accused of corruption. Or why Rajoy continued to send Bárcenas friendly text messages even long after it emerged that Bárcenas had illegally moved many millions of euros into bank accounts abroad. The opposition in Spain is demanding Rajoy's resignation. On Monday he agreed to appear before parliament to discuss the allegations after the opposition threatened to call a symbolic vote of no-confidence. The date for the appearance is set for August 1, before the prime minister leaves for holiday in his native Galicia. Even within the usually closed ranks of the conservative People's Party, the calls to replace Rajoy are growing louder. Political commentators in Madrid believe Sáenz de Santamaría, Rajoy's right-hand woman, could well become his replacement. The diminutive lawyer, often seen in high heels, is already Spain's most influential female politician. Since taking office in December 2011, she has coordinated joint work between the cabinet and her party's parliamentary group, and now between the different departments that handle economic matters as well. She also oversees the country's intelligence service. Austerity with a Smile Spain's general population knows Sáenz de Santamaría's face, with her large brown eyes and conservative makeup, mainly from television. After each Friday's cabinet session, it is Sáenz de Santamaría who goes on air to announce the ministers' decisions, which often concern new and painful austerity programs. Despite this, she remains the most popular woman in Rajoy's government, which polls show has otherwise taken a brutal nosedive in public opinion. Late this June, Sáenz de Santamaría announced a tax hike on tobacco and alcohol. She delivered this news as a non-stop cascade of facts, in a firm voice and at breathtaking speed. After 15 minutes of this outpouring, Sáenz de Santamaría cast a quick glance at her purple plastic watch, then took just a few questions from journalists. Asked about the donations scandal surrounding her party, she muttered, "We respect the justice system's verdicts," then swept from the room. While growing up in Spain's Castile region, Sáenz de Santamaría was an unusual child, who studied every day even during vacations, according to one school friend. She completed law school at the top of her class, then passed the difficult exam to become a lawyer in Spain's civil service. Former professors and fellow students praise her feats of memory, her tenacity and her hardworking attitude. Cleaning Up the Mess Sáenz de Santamaría first became involved in politics in the summer of 1999, when she introduced herself to Rajoy, then deputy prime minister and looking for a legal advisor. "Does it bother you to constantly have to clean up the mess?" is the decisive interview question Rajoy asked the lawyer, then 29. "Not in the least," she answered. When her boss became interior minister two years later, Sáenz de Santamaría became part of his inner circle of advisors, overseeing immigration matters. In Spain's 2004 parliamentary elections, Rajoy was his party's leading candidate for the first time and asked Sáenz de Santamaría to assist in writing the party's platform. It was at this point that Sáenz de Santamaría first joined the People's Party. Following the party's 2011 electoral win, Rajoy tasked her with preparing the transfer of power from the Socialist

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Workers' Party to the People's Party. This was just days after Sáenz de Santamaría, then 40, gave birth to her first child. One reason Rajoy is pleased to be able to rely on his deputy prime minister is that he can always count on her to have his back at the expense of developing a political profile of her own. But is that qualification enough for Sáenz de Santamaría to take charge of the government? Friendly with Merkel When fellow People's Party members talk about the "Soraya factor" in the current government, they mean the politician's capacity for mediating between various parties and her willingness to work to the point of exhaustion, something she demands of her staff. Several times, Rajoy has sent Sáenz de Santamaría to talk to Angela Merkel, since he himself has little idea what to say to the German chancellor. Sáenz de Santamaría proudly displays a photograph of herself and Merkel on a bookshelf in her office. The "Vice," as colleagues call her -- short for the Spanish vicepresidenta -- keeps her private life strictly private. She reacted in anger to television journalists who broadcast footage of a demonstration held in front of her home in the wealthy residential area Fuente del Berro, and only rarely lets herself be seen in a nearby park pushing her son Iván around in a stroller. Sáenz de Santamaría's husband has been the primary caregiver for their son, taking professional leave to do so. But if the politician soon finds herself and her family moving into Moncloa Palace, the official residence of Spain's prime minister, it could have an added advantage. Without a long commute in an official government car, it could also give her more time with her family. Translated from the German by Ella Ornstein URL: • http://www.spiegel.de/international/europe/rajoy-deputy-santamaria-could-be-next- spanish-prime-minister-a-912554.html Related SPIEGEL ONLINE links: • Photo Gallery Spain's Most Powerful Woman http://www.spiegel.de/fotostrecke/fotostrecke-99406.html • Luxury Revamp Party To End for Mallorca's German Tourists (07/22/2013) http://www.spiegel.de/international/zeitgeist/0,1518,912410,00.html • Going, Going, Gone Crisis-Plagued Madrid Sells Out (07/18/2013) http://www.spiegel.de/international/business/0,1518,911438,00.html • Downward Spiral Southern Europe Remains Stuck in Crisis (07/03/2013) http://www.spiegel.de/international/europe/0,1518,908856,00.html • Viva la Siesta Should Southern Europe Really Be More German? (06/28/2013) http://www.spiegel.de/international/europe/0,1518,908109,00.html

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The Irish Times Financial Services Tuesday, July 23, 2013 IMF distances itself from Ashoka Mody comments on Ireland Pamela Newenham, Judith Crosbie Last Updated: Monday, July 22, 2013, 15:10 The International Monetary Fund has distanced itself from comments made by its former chief of mission to Ireland Ashoka Mody. Mr Mody had said austerity was a “potentially self-defeating policy” because of the lack of growth and no reduction in debt levels it had resulted in. He told RTÉ’s This Week programme that the likelihood of Ireland getting money back from the European Stability Mechanism for its legacy banking debt was “almost zero”. He also said Ireland should consider greatly reducing the policy of austerity. However, the IMF today distanced itself from these comments saying: “Mr Mody has retired from the IMF and his views do not represent the Fund’s position.” This morning Tánaiste Eamon Gilmore said the Government realises Ireland’s route to economic recovery cannot be based on austerity alone. Reacting to comments by Mr Mody, that austerity must end for the economy to grow, Mr Gilmore said: “when the Government was formed we determined that the route to recovery could not just be by budget consolidation alone. There had to be a strategy for jobs and growth.” He said the government had been pursuing a strategy to boost the economy and getting growth into the economy. “That is why we brought in last year a stimulus package announced by Brendan Howlin. That is why we have brought forward the action plan on jobs.” Mr Gilmore said the Government was going to continue negotiating to secure the best possible deal for the Irish taxpayer reduce as much as possible the burden on the Irish taxpayer. “..At the beginning of the lifetime of this Government about renegotiating the bailout deal we were told it can’t be done. We have renegotiated the bailout deal. When we sought a reduction in our interest rate we were told it can’t be done. We secured a reduction in our interest rate, far greater in fact than most people expected.” Asked whether Ireland should implement a €3.1 billion reduction in spending in this year’s budget demanded by the EU-IMF troika, Mr Mody said this figure should be “considerably lowered”. “I would even ask the question why can we not imagine and consider the possibility that for the next three years, as an experiment, there be no further fiscal consolidation,” he said yesterday.

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Mr Gilmore also criticised Fianna Fáil following claims by the party that Taoiseach Enda Kenny mislead the Dáil over his contacts with Anglo Irish Bank executives while he was leader of the Opposition. “Fianna Fáil are in no position to ask any questions of anybody about this or make any remarks about hypocrisy. The only hypocrisy in all this is Fianna Fáil,” he told RTÉ’s Morning Ireland programme. http://www.irishtimes.com/business/sectors/financial-services/imf-distances-itself-from- ashoka-mody-comments-on-ireland-1.1471321

The Irish Times Business Tuesday, July 23, 2013 Former IMF official warns austerity could be ‘self-defeating’ for Ireland Judith Crosbie Last Updated: Sunday, July 21, 2013, 20:37 A former senior IMF official has warned that austerity must end for the economy to grow while a Labour Party paper has said more welfare cuts “may not be politically deliverable”. Austerity was a “potentially self-defeating policy” because of the lack of growth and no reduction in debt levels it had resulted in, said former IMF chief of mission to Ireland Ashoka Mody. “We have to ask ourselves why Ireland is not growing . . . It’s hard for me to believe that austerity is not contributing to this,” he told RTÉ’s This Week. It had become “orthodoxy that the only way to establish market credibility” was to pursue austerity policies. But five years of crisis and two recent years of no growth needed “deep thinking” on whether this was the right course of action, said Mr Mody. Asked whether Ireland should implement a €3.1 billion reduction in spending in this year’s budget demanded by the EU-IMF troika he said this figure should be “considerably lowered”. “I would even ask the question why can we not imagine and consider the possibility that for the next three years, as an experiment, there be no further fiscal consolidation,” he added. “The only instrument left to address this in the short term is the fiscal instrument and that requires complete rethinking of how aggressive and how persistent the austerity has to be,” Mr Mody said. There was “not one single historical instance” where austerity policies have led to an exit from heavy debt burden. Changing policies could possibly lead to growth, reduce debt levels and also prompt a “psychological boost” for the economy, he added. Mr Mody said the likelihood of Ireland getting money back form the European Stability Mechanism for its legacy banking debt was “almost zero”. “I would be astonished if it happens,” he added.

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During a meeting last week the EU-IMF troika urged the Government to deliver a €3.1 billion cut in budget spending. But some Ministers are resistant to such level of cuts. A paper circulated among senior Labour Party officials states budget cuts will have to be “lowered considerably”. The level of welfare cuts expected in this October’s budget are “very problematic and politically undeliverable”, the Sunday Business Post reported. The cuts would be “regressive from a poverty perspective and have a disproportionate impact on certain cohorts”, the paper added. Minister for Finance Michael Noonan said last week the Government would not be ending its austerity policy, despite savings made after reform of debt deals. http://www.irishtimes.com/business/former-imf-official-warns-austerity-could-be-self- defeating-for-ireland-1.1470669

ft.com Comment Opinion July 22, 2013 7:36 pm It is wrong to portray Germany as the euro winner By Hans-Werner Sinn The eurozone should be closer to the old Bretton Woods currency system, writes Hans- Werner Sinn

There are some things that reasonable people can largely agree on regarding the eurozone’s problems: the monetary area is stuck in a crisis that has brought about unbearable unemployment to southern Europe. That problem cannot be solved satisfactorily through deflation since that would make bankruptcies soar among over- indebted households and companies. The crisis was triggered by the US financial turmoil and Germany accumulated large current account surpluses after the introduction of the euro that are the mirror image of the distressed countries’ deficits. But reasonable people can differ: Niall Ferguson wrote recently in the Financial Times that the euro helped Germany because it created current account surpluses at the expense of the southern countries. This view is wrong. Current account imbalances are capital flows. When capital flows from country A to country B, A slows down and B experiences a boom. The booming country’s imports rise, while rising wages depress its exports. The opposite holds for the partner people. For that reason alone it is absurd to say that a country “profits” from a current account surplus or “suffers” a deficit. That notion was laid to rest in the 19th century.

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More ON THIS STORY/ Eurozone house prices hit seven-year low/ UK to unveil initial review of EU powers/ In depth Eurozone in crisis/ Portugal’s coalition seeks to soldier on/ Niall Ferguson Merkel’s ‘deutsche Michel’ ploy is flawed ON THIS TOPIC/ Constanze Stelzenmüller We have good cause to abhor the secret state/ Trittin aims to be Green kingmaker/ The Short View China’s credit crunch buffets Berlin/ The Macro Sweep US, Germany, Malaysia IN OPINION/ Ian Bremmer and David Petraeus Abe’s win is great news/ Mark Schneider Quarterly reporting too late for investors/ John McDermott The flimsy youth contract/ Steve Hanke and Garbis Iradian Heavier sanctions on Iran The now-troubled countries were the recipients of the capital mobilised by monetary union. The euro eliminated exchange risk so investors in the southern countries accepted lower yields. Capital inflows fuelled booms that turned into bubbles, causing massive current account deficits. The bubble burst when investors refused to continue financing these deficits, leaving uncompetitive economies. Germany, under the euro, was the largest capital exporter and plunged into a deep slump. Only one-third of its savings was invested at home. As a result, during the early years of the euro, its net investment and growth rates were the lowest in Europe. Rising unemployment forced the Schröder government in 2003 to enact painful social reforms. When the euro was announced in 1995, Germany’s gross domestic product per capita was the second-highest among the current euro countries. Now it is seventh. That’s not exactly the performance of a “euro winner”. Things started to perk up for Germany only after the credit bubble in southern Europe burst, because it became a safe haven for its savings. Confidence in German property fuelled a construction boom which, if capital is not artificially escorted abroad, will gradually eliminate the current account imbalances. Herein lies another disagreement between us. Prof Ferguson suggests institutionalising redistribution among the euro countries through a deposit guarantee, a eurozone budget and eurobonds. These would perpetuate the structural differences in competitiveness that arose from the southern European credit bubble. They would maintain wages that do not reflect productivity and would turn a temporary crisis into chronic malaise. They would also revalue the euro, further undermining the crisis-hit countries’ competitiveness. Muddling through is the only solution. Germany must accept more inflation while the southern countries reduce theirs to bring about the necessary realignment of relative prices. This process, not much in evidence among the crisis-stricken countries bar Ireland, requires tough austerity measures. Only modest lending between governments will therefore be required. The European Stability Mechanism has already been generously endowed for this task. Countries that cannot cope should be allowed to exit the euro and be readmitted after they have devalued and implemented structural reforms. The eurozone is no unitary federal state; the euro cannot function as the dollar does. It should be somewhere closer to the old Bretton Woods currency system, under which countries could exit and re-enter at different prices. Greece would benefit from orderly exit followed by devaluation. Exit should be accompanied by haircuts that convert debt into national currencies and an option to re-enter at a later date would strengthen the country’s zest for reform. A common debt moratorium for overly indebted countries not exiting the euro may also be needed.

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This implies risks for investors. But the risk posed by mutualisation of debt through eurobonds is much greater, as US history shows. After the US mutualised state debts in 1791 and, again, after the second war against Britain in 1813, states went on borrowing binges. A credit bubble emerged that burst in 1837 and pushed more than half of all states into insolvency. As Harold James of Princeton has shown, the only result of debt mutualisation was strife. The US and Switzerland have no-bail-out clauses for states and cantons. Otherwise, they would have to bestow upon their central governments intrusive intervention rights. But a European federal state, if ever established, will surely not be more centralistic than the US or Switzerland. No matter how you look at it, mutualising debt is indefensible. The writer is professor of economics at the University of Munich and president of the Ifo Institute http://www.ft.com/intl/cms/s/0/bbb2176a-ed70-11e2-8d7c- 00144feabdc0.html#axzz2ZlHBlKkT

ft.com World Europe GLOBAL INSIGHT July 22, 2013 1:40 pm Schäuble keeps quiet on mounting cost to Germany of Europe’s woes By Tony Barber in Berlin Concerns grow some of the billions lavished on Greece will never be repaid, writes Tony Barber

©AP Wolfgang Schäuble, Germany's finance minister Spare a thought for Wolfgang Schäuble, Germany’s 70-year-old finance minister. A politician of unparalleled experience in Angela Merkel’s centre-right government, he carries the flag for those who hold that the eurozone’s travails will be, in the long run, an opportunity to advance European integration. Yet two government crises in the space of a month, the first in Greece and the second in Portugal, underline how his vision risks being buried under mountains of unrepaid southern European debt. Bruised and battered, the ruling coalitions in Athens and Lisbon limp on, scarcely more confident than the societies they govern that obedience to German-inspired policy prescriptions will save their countries. More ON THIS TOPIC/ ECB quells markets with ‘Dirty Harry’ act/ Eurozone assets head off on summer rally/ Dublin seeks credit line to help exit bailout programme/ Report criticises handling of Dexia’s collapse 281

GLOBAL INSIGHT/ How will Abe spend his political capital?/ Republicans enjoy best of both worlds on Obamacare/ US must end back-seat approach on Iran/ Disillusionment offers Spain’s Rajoy cover When Mr Schäuble visited Athens last week, the leftist Greek newspaper Avgi welcomed him with the abrasive headline: “Hail Schäuble! We who are about to die salute you.” Behind the scorn and despair of this rhetorical flourish lies the smouldering conviction of millions of Greeks that, although their own rulers bear the original responsibility for six years of economic recession and mass unemployment, Germany has made matters worse. Ahead of Mr Schäuble’s trip, Greek legislators dispatched for trial, on allegations of abuse of office, a man familiar to him from hours of late-night sessions at the eurozone bargaining table. As finance minister in Athens from 2009 to 2011, George Papaconstantinou clung to the view that constructive relations with Germany were a sine qua non of Greece’s effort at self-correction. Parliament followed up its punitive measure by reluctantly passing legislation, supported by Germany, that sets the stage for the dismissal of thousands of state employees in return for more drip-fed financial support from Greece’s international creditors. In protest, Greek trade unions held a general strike. Aware of the acrid political atmosphere in Athens, Mr Schäuble came bearing gifts: €100m in state-backed loans for small and medium-sized Greek businesses. But what Greece really needs, to kindle a flame of hope in its future, is another restructuring of its foreign debt. Conventional wisdom holds that it would be suicidal for Mr Schäuble, or any German politician, to speak this unpalatable truth to voters before Germany’s September 22 national election. Unlike the Greek debt haircut of March 2012, which clipped private sector lenders, any future restructuring would shear the locks of official creditors, including Germany, which now hold over 90 per cent of Greece’s debt. This would represent a revolution in the eurozone crisis. So far, the bailouts of Greece, Ireland, Portugal, the Spanish financial sector and Cyprus have cost German taxpayers much in loans and guarantees, but not one cent in hard, unrecoverable cash. Indeed, the €110bn EU-International Monetary Fund rescue of Greece in May 2010 was as much about protecting German banks, which had lent recklessly across southern Europe, as it was about restoring Greece’s financial health. Yet in their bones and wallets, German voters already sense that some of the billions of euros lavished on Greece since 2010 will probably never be repaid. To that extent, a second Greek debt restructuring would not shock German taxpayers and destabilise the political scene, although legal hurdles might need to be jumped at the nation’s constitutional court. More dangerous, for its impact on German political and public opinion, would be the dropping of a different penny: the growing possibility that debt write-offs, or extra financial aid, will have to be made available not just to Greece but to Portugal and Cyprus. Spain’s banks are not wholly out of the woods, either. The Portuguese case is especially relevant because, next to Ireland, no country has striven more earnestly to obey the rules for recovery laid down by Germany and other creditors. Yet the medicine, insofar as it is working at all, is not working fast enough to

282 assure Portugal’s scheduled return next year to international debt markets. As for Cyprus, the duration and intensity of its economic and social collapse are unmeasurable. The question, then, that threatens to dominate German public debate is: “Greece, Portugal, Cyprus . . . Where will we Germans draw the line?” The only certainty is that no answer will come before September 22. http://www.ft.com/intl/cms/s/0/5bb17dae-f2c7-11e2-a203- 00144feabdc0.html#axzz2ZlHBlKkT

ft.com Companies Financials July 23, 2013 1:58 am Kay review chimes with spirit of the times By David Oakley, Investment Correspondent It was billed as a groundbreaking blueprint for corporate responsibility, investment – even the future of capitalism itself. And, exactly one year on from its publication, The Kay Review of UK Equity Markets and Long-Term Decision Making appears to have made a deeper mark on the City than was first envisioned by many sceptics, who had been quick to criticise the document as too high-brow and impractical when it first appeared. More ON THIS STORY/ The Kay Review a one-year progress report/ In depth London fights for its future/ John Kay Prof Doom predicts further financial crisis/ Financial system ‘waiting for next crisis’/ BIS warns of dangers of cheap money ON THIS TOPIC/ Report into HBOS failure in ‘final stage’/ New regulator warns of heavy penalties/ Top law firms boosted by fees from probes/ MPs cast doubt on Treasury’s resolve IN FINANCIALS/ Oriel and Panmure abandon merger talks/ Munro named Aviva Investors chief/ Blackstone boosted by SeaWorld IPO/ Deloitte to face a further MG Rover hearing Of the 17 recommendations in the 40,000 word report, most have been addressed or are in the process of being carried through by regulators or the industry itself. Even the author, John Kay – the London School of Economics professor and Financial Times columnist who recently expressed a gloomy view of the state of the financial system – admits to being pleasantly surprised by the support his review has gained. Looking back to last July, Professor Kay suggests his report struck a chord with the spirit of the times, and believes the business and investment community have understood the need for a more long-term approach to company decision-making. “We have stumbled in the right direction,” he says. “There has been a big change in the way people think about financial services since the financial crisis. There is a cultural change. People have realised that there was a need to go in a different direction after the excesses.” One of his key recommendations was a call to end quarterly company reporting, and the focus on short-term corporate performance. Both the UK and European lawmakers now plan to scrap this requirement for big, listed companies.

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Progress has also been made on the controversial issue of executive pay, with companies attempting to align salaries and bonuses more closely to longer-term performance – and scrutinise them. From October, UK companies will be subject to a binding shareholder vote on executive pay. Other important areas being addressed include the development of the Stewardship Code: the industry’s guidelines for investors. The code has taken on a more expansive remit, focusing on strategic issues and questions of corporate governance, as Kay called for. Investors have also seen significant progress made on fostering productive engagement between shareholders and companies. Industry bodies including the Investment Management Association, the Association of British Insurers and the National Association of Pension Funds will report on plans to create an investor forum in November. Other recommendations that are being adopted include the full disclosure of all costs by fund managers – including actual or estimated transaction costs – and improvements in the quality of annual reports. Peter Montagnon, senior investment adviser at the regulator the Financial Reporting Council argues that there is a “great prize” for the City, if it can carry through the Kay recommendations. “The Kay reforms will help growth, jobs, returns, savers and the health of the economy,” he says. “It is about improving the capitalist system.” It will by nature be a gradual improvement, observes Matthew Fell, director for competitive markets at the Confederation of British Industry. “There was no silver bullet, but the review has been very helpful,” he says. “The main theme was this need for more long-term decision making. There has also been a deepening of engagement between companies and investors.” But in spite of the progress of the past 12 months, some concede that there is a long way to go – and the pressure on companies and fund managers to make short-term profits remains great. Professor Kay also worries that investment banks remain “the elephant in the room”. He says it is not clear how they can fit in to world in which complex financial products and mega-bonuses have no place. Daniel Godfrey, chief executive of the Investment Management Association, says: “A lot of things are happening as a result of Kay. So far we are winning, but Kay can only be deemed a success if there is permanent change. It is like being top of the table of the Premier League at Christmas, half way through the football season. There is a feeling of satisfaction, but we can’t celebrate yet.” ------Major recommendations of The Kay Review • Mandatory quarterly reporting obligations should be removed. • Companies should structure directors’ remuneration to relate incentives to sustainable long-term business performance. • The Stewardship Code should be developed, focusing on strategic issues as well as questions of corporate governance. • An investors forum should be established to facilitate collective engagement by investors in UK companies. • Asset managers should make full disclosure of all costs, including actual or estimated transaction costs, and performance fees charged to the fund. http://www.ft.com/intl/cms/s/0/a1461042-f09b-11e2-929c-00144feabdc0.html#axzz2ZlHBlKkT

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ft.com/markets MARKETS INSIGHT July 22, 2013 9:50 am Bailouts can turn a profit for central banks By Andreas Utermann Attention should focus on net cost not money at risk How much do bailouts really cost creditor countries? The question is particularly pertinent in light of the recent German Constitutional Court hearings regarding the scope of the European Central Bank’s new sovereign bond buying programme, called Outright Monetary Transactions, and the renewed concern that Greece may need further financial assistance. Just as banking crises tend to entail transfers of risk from the private to public sector, sovereign debt crises involve supranational bodies such as the International Monetary Fund or the ECB assuming some of those risks. Attention, though, tends to focus on the headline numbers involved – the money at risk – much more than on the likely, or indeed ultimate, net cost to the provider of financial support. More ON THIS STORY/ Strategy switch at Bank of England/ ECB to accept more ABS as collateral/ Q&A the Greek crisis revisited/ Q&A Why is a German court probing the ECB? ON THIS TOPIC/ Yen climbs on election risk concerns/ Sterling rebounds on unanimous MPC vote/ Stimulus tapering years away, says BoE’s Paul Fisher/ Hedge funds lead Treasuries sell-off MARKETS INSIGHT/ Indonesia faces big value chain obstacles/ Fed’s jobs focus will drive shares higher/ Central banks risk sharing too much with the markets/ Emerging world needs a new economic model It is instructive to reflect on those net fiscal costs, distinguishing between governmental interventions such as guarantees, equity stakes or nationalisation of institutions on the one hand, and activity – such as liquidity support, loans or asset purchases – that constitutes part of a central bank’s role as lender of last resort. Evidence for government guarantees and equity ownership is somewhat mixed, though the costs generally prove less onerous than originally feared. As part of its troubled asset relief programme in the wake of the global financial crisis, the US Treasury made a number of equity investments. On the positive side of the ledger, its stake in AIG yielded a $5bn gain and its investments in Citigroup and Bank of America a further $4.5bn. However, a positive cash return on the US Treasury’s automotive investments seems unlikely. In the UK, the government’s investment in Lloyds Banking Group is now tantalisingly close to break-even, though its stake in Royal Bank of Scotland remains below water. Note, though, that the government made £5bn on RBS’s participation in and LBG’s exit from the Asset Protection Scheme.

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The jury remains out on the nationalisation of Northern Rock and subsequently Bradford & Bingley: the sale of the restructured Northern Rock resulted in a paper loss, but the government’s interest-bearing loan is expected to be repaid in full with the slow winding down of the remaining book of assets. By contrast, the record of central bank lender of last resort activities is better, with bailouts typically ending up profitable for those taking on the risk. In its response to the Asian financial crisis, the Hong Kong Monetary Authority bought HK$118bn of assets during a market operation in 1998, culminating in an equity portfolio that included a 10 per cent stake in HSBC. It eventually recovered HK$208bn, representing a gain of HK$90bn. The US Federal Reserve’s purchase of nearly $30bn of Bear Stearns assets in spring 2008 generated a positive result of $6.6bn, representing a more than 20 per cent return. In the case of the Fed’s loans to and asset purchases from AIG, it was able to add $17.7bn to the Treasury’s gain. The Bank of England’s Special Liquidity Scheme, whereby financial institutions were allowed to swap illiquid assets for UK Treasury bills for up to three years, generated a profit of £2.3bn by the time it was wound up in January 2012. Likewise, the Bank’s Asset Purchase Facility, which started life in January 2009 in order to buy private sector assets and is now the vehicle for its quantitative easing programme, has so far accumulated more than £31bn, which is now being distributed to the UK Treasury at regular intervals. It is clear that at some point these payment streams will reverse, but under the scenarios outlined by the BoE, all but one of its published scenarios point to a net gain. Through its covered bond and securities market programmes, the ECB acquired €276bn in assets between 2009 and 2012, when it was superseded by OMTs. This includes substantial peripheral sovereign debt – more than 50 per cent of outstanding Greek debt and a quarter of Portuguese debt – as well as commercial paper. As these assets will typically be held to maturity, coupon is the main source of gains rather than capital appreciation. Assuming no further defaults, these programmes should generate a net gain of around €70bn-€80bn, including €9bn on the Greek debt. Viewed in this light, the lender of last resort plays a critical yet ultimately profitable role in the face of banking or sovereign debt crises. Should the situation arise that Greece requires further financial assistance involving public participation for the first time, then at least some of the cost would be made good by the proceeds of the ECB’s other earlier programmes. If this was better understood, perhaps the popular opposition to bailouts would be tempered. Andreas Utermann is co-head and global chief investment officer at Allianz Global Investors http://www.ft.com/intl/cms/s/0/50015146-ee21-11e2-816e- 00144feabdc0.html#axzz2ZlHBlKkT

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Yukon Huang July 23, 2013 Unbalanced growth will help China avoid a slump Markets are having a hard time interpreting China’s economic slowdown and evaluating policy options. At one extreme, some observers are talking about a potential dynastic collapse. But most have turned to the notion that economic growth needs to be more consumption driven since the almost universal view is that China’s growth is unbalanced, with consumption as a share of gross domestic product having declined steadily to below 35 per cent – the lowest level of any major economy – while its investment share rose to above 45 per cent, correspondingly the highest. The reason for this imbalance is often attributed to low interest rates or an undervalued exchange rate. This has been the easy explanatory option since financial markets are comfortable with prices driving outcomes. But in his article in The New York Times last week, Paul Krugman is unique among prominent commentators in getting it right. He notes that China’s unbalanced growth is explained by the Nobel Prize-winning model by Arthur Lewis that shows how the transfer of surplus workers from the rural sector to the modern economy, complemented by rising investment, leads to rapid but unbalanced growth. The model also lays out the conditions when labour supplies tighten, growth slows and China’s economy eventually becomes more balanced – referred to as the “Lewis turning point” – and this as argued by Mr Krugman is causing China to “hit its Great Wall”. But then he gets it wrong by saying that this urbanisation cum industrialisation process in China “keeps wages low even as the economy gets richer” and that its economy needs to rebalance soon to avoid a nasty slump. Like many others Mr Krugman sees rebalancing as the solution if China wants to avoid a premature economic slowdown that has prevented the majority of aspiring developing countries from reaching high- income levels, most notably in Latin America, a phenomenon which has become known as the “middle-income trap”. In fact only a handful of non-European economies managed to escape the middle- income trap over the past half century and most of them were in East Asia – Japan, South Korea, Taiwan and Singapore. Less well recognised is that these economies went through several decades of unbalanced growth with consumption as a share of GDP falling by 20-30 percentage points before they became more balanced – a path which China appears to be following. In fact, only unbalanced economies have been successful in moving to high-income status while “trapped” Latin American economies and lagging southeast Asian countries have balanced growth paths. But why is successful growth so unbalanced? The explanation lies in the structural shifts as an economy moves from being dependent on agriculture to urban-based industries and services. China’s population has become more than 50 per cent urbanised compared with 20 per cent three decades ago. As millions of migrant workers moved 287 annually from smallholder agriculture, where labour’s share of the value of production is about 90 per cent, to industry or services, where labour’s share of production is closer to 50 per cent (the rest going to other inputs), the effect in the national accounts is that labour’s share of GDP automatically declines and in turn consumption as a share of GDP falls. Contrary to popular perceptions, however, which Mr Krugman also falls victim to, labour is not suffering in the urbanisation process and there is nothing perverse about this declining consumption share since migrants are earning and consuming multiples more than they used to, businesses are able to expand through increased labour absorption and rising profits, and the country benefits from higher productivity and double-digit growth rates. Growth in consumption and wages has been much higher in the economies cited following unbalanced rather than balanced growth paths at comparable stages in their development process. Actual consumption expenditures in China specifically have been increasing steadily by 8 per cent a year, led by double-digit growth in real wages – the highest of any major developing or developed economy over the past decade and half. Thus the premise that more balanced growth means faster growth in wages or consumption is simply not true. Motivated by the view that imbalance is bad and consumption is being repressed, many commentators then mistakenly recommend that China’s growth needs to be more consumption-driven. There is no such concept in economic theory as consumption- driven growth. Sustained growth can only come from increasing factors of production – labour or capital – and productivity. China’s labour force is now shrinking (although its quality can be improved) and its investment rates have reached their limits (although its composition must change). Thus the challenge for the country’s new leadership is pushing forward with reforms that would increase productivity. The danger is that by artificially stimulating consumption and rebalancing prematurely, China risks losing the productivity gains that can come from a reform agenda driven by a more efficient urbanisation process and allowing the private sector to realise its full potential. South Korea, Japan and Taiwan began to rebalance at an income level between $12,000 and $15,000 (in adjusted purchasing power parity terms). China’s per capita income is now about $9,000. If Beijing implements the necessary reforms to realise these productivity gains then its economy will not hit the China Wall that Mr Krugman refers to until 2020. By that time, China would be the world’s largest economy and well on its way to escaping the middle-income trap. If China gets it right, then rebalancing will eventually occur as a byproduct of a sustainable growth path but not as the intrinsic objective. The author is a senior associate at the Carnegie Endowment and a former World Bank country director for China http://blogs.ft.com/the-a-list/2013/07/23/unbalanced-growth-helps-china-avoid-a- slump/#axzz2ZrZDVi7i

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Economía El gasto en eventuales sube el 9,5% en plena congelación salarial del Estado Pepa Montero 22/07/2013 - 8:19 Mientras, los pagos a funcionarios caen el 2%

El ministro de Hacienda y Administraciones Públicas, Cristóbal Montoro. Foto: Archivo Enlaces relacionados El seguro de salud de los funcionarios en peligro Trabajadores eventuales y altos cargos de la Administración Central escapan mejor parados que los funcionarios de carrera a la congelación salarial y de empleo impuesta por el Gobierno de Mariano Rajoy para intentar rebajar la nómina global del sector público. Un objetivo en el que el Estado apenas ha avanzado en los últimos tres años. De hecho, a pesar del tijeretazo del 5% que dio a los sueldos públicos el Gobierno socialista en 2010, la posterior congelación salarial en 2011, la supresión de la paga extra en 2012 y las actuales retribuciones congeladas en la Administración, lo cierto es que la nómina global del Estado tan sólo se abarató el 2,1% interanual hasta diciembre del año pasado. Así se desprende del presupuesto de gastos y pagos mensuales, que ha sido actualizado recientemente por la Intervención General de la Administración del Estado (IGAE), con algunos datos, cuanto menos llamativos, que hacen dudar de la efectividad y/o proporcionalidad de los ajustes laborales. Así, por ejemplo, hasta finales de mayo, el Estado pagó 14,17 millones de euros a su personal eventual, lo que significa el 9,5% más que los 12,94 millones que suponía esa partida en el mismo mes del año anterior. Una subida considerable, sobre todo teniendo en cuenta la disminución del 2% encajada por los pagos a funcionarios hasta mayo, que han pasado a suponer 4.410 millones de

289 euros, es decir, 89 millones de euros menos de su alcance en idéntico periodo del ejercicio precedente. Esta tendencia al alza de los pagos al personal temporal es una constante desde primeros de este ejercicio, ya que, a fecha 31 de enero de 2013, estos pagos del Estado se incrementaron el 21,3 por ciento (4,13 millones en total) sobre los 3,4 millones del mismo mes de un año antes. Y contrasta de manera clara con la situación existente en enero de 2012, cuando los gastos en nóminas de los trabajadores eventuales sufrieron un tajo del 21,1 por ciento, resultado de unos pagos de 3,4 millones de euros, frente a los 4,31 millones que recibían a finales de enero de 2011. Es decir, y aunque parezca paradójico, dos años después, la Administración del Estado comenzó 2013 con prácticamente los mismos gastos por personal eventual que en 2011, ya que lo que recortó un año lo añadió al siguiente, casi en la misma cantidad. En una similar tónica al alza, los gastos del Estado en personal de confianza -esto es, altos cargos que suelen ir ligados a los relevos en los distintos equipos ministeriales-, lejos de disminuir, registraron un aumento del 0,5 por ciento interanual hasta finales de mayo pasado. En concreto, supusieron 29,86 millones de euros, en comparación con los 29,7 millones que costó retribuir a los altos cargos en mayo de 2012. Un alza levísima, pero que demuestra que meter la tijera en el número y retribución de los cargos de confianza sigue siendo una asignatura pendiente de todas las Administraciones Públicas, y no tan sólo de las autonómicas, como a menudo critican expertos y miembros del Gobierno. Menor nómina funcionarial Donde el Estado sí ha realizado una rebaja sistemática de sus nóminas es en el capítulo de los pagos al personal funcionarial. En detalle, y según las cifras de la Intervención General de la Administración del Estado, que pueden consultarse en la web del Ministerio de Hacienda, las retribuciones a los funcionarios hasta mayo pasado alcanzaron el montante de 4.410 millones, lo que indica una disminución del 2% en comparación interanual. Y, a su vez, los 4.499 millones que representaban hasta mayo de 2012 las retribuciones a funcionarios eran un 0,7 menores que los 4.532 millones hasta mayo de 2011. No obstante, y pese a este ahorro palpable en las nóminas de los funcionarios, el Estado no ha sido capaz de rebajar sus gastos de personal, ya que los pagos totales acumulados hasta mayo ascendieron a 10.184 millones de euros (10.139 millones el año pasado), con un incremento de 45 millones, lo que supone un alza del 0,4%. Según detalla en su informe la Secretaría de Estado de Hacienda, si se distingue entre los pagos de las clases pasivas y los correspondientes al personal activo, la variación acumulada sería del 5,5% y del -2,9%, respectivamente. En este sentido, los datos hechos públicos por el Ministerio achacan la subida acumulada en los cinco primeros meses a los mayores pagos a clases pasivas, consecuencia del aumento neto en el colectivo de pensionistas y del incremento del 1% de las pensiones. http://www.eleconomista.es/interstitial/volver/directm12/economia/noticias/5010328/07 /13/El-gasto-en-eventuales-sube-el-95-en-plena-congelacion-salarial-del-Estado.html

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ft.com Markets Capital Markets July 22, 2013 3:56 pm Draghi’s ‘Dirty Harry’ act keeps euro crisis at bay By Michael Steen in Frankfurt and Ralph Atkins in London Mario Draghi’s promise a year ago that the European Central Bank would do “whatever it takes” to save the euro has been celebrated as a turning point in the eurozone’s sovereign debt crisis, replacing fear of a euro collapse with the promise of intervention. Yet the bond-buying tool that the bank developed to back up that pledge, outright monetary transactions, has still not been tested. The ECB president calls OMT the “most successful monetary policy measure undertaken in recent times” but has kept the finer details of the programme under wraps. More ON THIS TOPIC/ Global Insight German finance minister’s vision at risk/ Eurozone assets head off on summer rally/ Dublin seeks credit line to help exit bailout programme/ Report criticises handling of Dexia’s collapse IN CAPITAL MARKETS/ Signs Japan asset tide is turning/ Detroit unease throws up muni opportunity/ Use of global depositary receipts doubles/ EU banks still pose systemic threat It is reminiscent of an early scene in the classic 1971 film Dirty Harry. The protagonist, played by Clint Eastwood, confronts a wounded bank robber who is reaching for his shotgun and tells him that the .44 Magnum pointed at his head is the world’s most powerful handgun, but then professes to have lost track of whether he had fired all six bullets in the chamber or just five. The question for the bank robber, and market participants tempted to test the ECB’s resolve, is “do you feel lucky, punk?” So far, like the bank robber, they have not tested their luck. Without the ECB buying a single bond, the market borrowing costs of stressed countries have tumbled. Yields on Spanish 10-year debt, which move inversely to prices, have fallen from more than 7.5 per cent to 4.6 per cent. Italy’s have dropped from 6.7 per cent to 4.3 per cent. The decline is even more dramatic for eurozone countries under official bailout programmes. Greek government yields have dropped from almost 30 per cent to about 10 per cent; Portugal’s from 12 per cent to 6.4 per cent. It is a far cry from July 26 last year when Mr Draghi, visiting London on the eve of the Olympic Games, wrongfooted his own communications team by ad libbing in a speech. At the time, borrowing costs in crisis-hit eurozone members were hitting levels that threatened the sustainability of public finances. For many global investors, the disintegration of Europe’s 13-year old monetary union seemed a real prospect. It took six more weeks of internal discussion, and a public row with the Bundesbank, to devise and announce OMT, a programme that could buy unlimited amounts of short- maturity bonds on the secondary market of any country that signed up to fiscal conditions – if the central bank decided its borrowing costs were being pushed higher by speculation of a eurozone break up.

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“OMT has provided an extremely effective cap,” says Benjamin Brodsky, head of fixed income allocation at BlackRock. But there may be flaws. “We’re not sure how it is really going to work in practice, whether there is going to be opposition even within the ECB. That is definitely a big unknown.” Since unveiling OMT in September, few further details have emerged and some elements have changed. An early suggestion that the programme might help those countries that were regaining market access shifted into a strict condition they have market access; and then again, in a recent EU memo, into a hint that a candidate like Portugal might be allowed access. After saying the ECB would publish OMT’s legal documentation “soon”, Mr Draghi has shifted stance to say it will only be published when a country applies. “There are a lot of fissures out there,” says Ken Buntrock, head of the global bond team at Loomis Sayles. Opposition to the plan has barely diminished at the Bundesbank, which would have to partake in OMT bond purchases, and Germany’s powerful constitutional court is looking into OMT, with the possibility that it tries to limit how it operates. While last year Spain was seen as the leading candidate for OMT, recent speculation has switched to Portugal, hit by political turbulence. “It is very likely that we will get countries applying for programmes that have OMT attached,” says Jacques Cailloux, international economist at Nomura. “It may well be applied to Portugal or Ireland.” Portugal’s recent wobbles do point to another success of OMT – Lisbon’s yields have risen in isolation, rather than pulling other stressed countries’ borrowing costs higher, as was the case in hotter phases of the crisis. Some observers believe the ECB will hold fire – unless the eurozone crisis re-emerges with the same ferocity as a year ago. Christopher Iggo, senior fund manager at Axa Investment Managers, says: “I think we’d need much bigger problems in Portugal – there would have to be real contagion – before the ECB used the OMT.” Erik Nielsen, chief economist at UniCredit, says: “OMT is the nuclear option and I don’t think they will need to use it . . . OMT may be the most effective when it is on the sidelines.”

While Dirty Harry was bluffing when he asked the bank robber to try his luck, the scene repeats itself later in the film, but this time the Magnum still has one bullet. One way or another, that moment may yet arrive for OMT. “My experience in markets is that these kinds of promises always get tested,” says Andres Sanchez Balcazar, co-head of global bonds at Pictet Asset Management. “Whether it is a bad GDP figure from Spain, Italian politics or the Fed tightening, something is going to give.” Additional reporting by Robin Wigglesworth in London http://www.ft.com/intl/cms/s/0/2597e96c-f2d9-11e2-a203- 00144feabdc0.html#axzz2ZlHBlKkT

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July 21, 2013 Detroit, the New Greece By PAUL KRUGMAN When Detroit declared bankruptcy, or at least tried to — the legal situation has gotten complicated — I know that I wasn’t the only economist to have a sinking feeling about the likely impact on our policy discourse. Was it going to be Greece all over again? Clearly, some people would like to see that happen. So let’s get this conversation headed in the right direction, before it’s too late. O.K., what am I talking about? As you may recall, a few years ago Greece plunged into fiscal crisis. This was a bad thing but should have had limited effects on the rest of the world; the Greek economy is, after all, quite small (actually, about one and a half times as big as the economy of metropolitan Detroit). Unfortunately, many politicians and policy makers used the Greek crisis to hijack the debate, changing the subject from job creation to fiscal rectitude. Now, the truth was that Greece was a very special case, holding few if any lessons for wider economic policy — and even in Greece, budget deficits were only one piece of the problem. Nonetheless, for a while policy discourse across the Western world was completely “Hellenized” — everyone was Greece, or was about to turn into Greece. And this intellectual wrong turn did huge damage to prospects for economic recovery. So now the deficit scolds have a new case to misinterpret. Never mind the repeated failure of the predicted U.S. fiscal crisis to materialize, the sharp fall in predicted U.S. debt levels and the way much of the research the scolds used to justify their scolding has been discredited; let’s obsess about municipal budgets and public pension obligations! Or, actually, let’s not. Are Detroit’s woes the leading edge of a national public pensions crisis? No. State and local pensions are indeed underfunded, with experts at Boston College putting the total shortfall at $1 trillion. But many governments are taking steps to address the shortfall. These steps aren’t yet sufficient; the Boston College estimates suggest that overall pension contributions this year will be about $25 billion less than they should be. But in a $16 trillion economy, that’s just not a big deal — and even if you make more pessimistic assumptions, as some but not all accountants say you should, it still isn’t a big deal. So was Detroit just uniquely irresponsible? Again, no. Detroit does seem to have had especially bad governance, but for the most part the city was just an innocent victim of market forces. What? Market forces have victims? Of course they do. After all, free-market enthusiasts love to quote Joseph Schumpeter about the inevitability of “creative destruction” — but they and their audiences invariably picture themselves as being the creative destroyers, not the creatively destroyed. Well, guess what: Someone always ends up being the modern equivalent of a buggy-whip producer, and it might be you.

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Sometimes the losers from economic change are individuals whose skills have become redundant; sometimes they’re companies, serving a market niche that no longer exists; and sometimes they’re whole cities that lose their place in the economic ecosystem. Decline happens. True, in Detroit’s case matters seem to have been made worse by political and social dysfunction. One consequence of this dysfunction has been a severe case of “job sprawl” within the metropolitan area, with jobs fleeing the urban core even when employment in greater Detroit was still rising, and even as other cities were seeing something of a city-center revival. Fewer than a quarter of the jobs on offer in the Detroit metropolitan area lie within 10 miles of the traditional central business district; in greater Pittsburgh, another former industrial giant whose glory days have passed, the corresponding figure is more than 50 percent. And the relative vitality of Pittsburgh’s core may explain why the former steel capital is showing signs of a renaissance, while Detroit just keeps sinking. So by all means let’s have a serious discussion about how cities can best manage the transition when their traditional sources of competitive advantage go away. And let’s also have a serious discussion about our obligations, as a nation, to those of our fellow citizens who have the bad luck of finding themselves living and working in the wrong place at the wrong time — because, as I said, decline happens, and some regional economies will end up shrinking, perhaps drastically, no matter what we do. The important thing is not to let the discussion get hijacked, Greek-style. There are influential people out there who would like you to believe that Detroit’s demise is fundamentally a tale of fiscal irresponsibility and/or greedy public employees. It isn’t. For the most part, it’s just one of those things that happens now and then in an ever-changing economy. http://www.nytimes.com/2013/07/22/opinion/krugman-detroit-the-new- greece.html?partner=rss&emc=rss&wpisrc=nl_wonk_b

JULY 20, 2013, 2:30 PM Who’s Your Daddy? By MILES CORAK Gus Wenner runs Rollingstone.com; his father gave him the job. But Jann Wenner, the magazine’s co-founder and publisher, was quick to assure critics of the appointment process that his son is terribly talented and had to prove himself before being given the reins. Apparently Gus worked his way up from more junior positions with the company, and demonstrated, according to his father, the “drive and discipline and charm, and all the things that show leadership.” Gus Wenner is 22 years old. He is certainly not the only kid just out of college, or even out of high school, working at daddy’s firm. Family contacts are a common way of finding both temporary internships and longtime careers. But whether because of blatant nepotism, or a privileged head start in life that nurtures talent and ambition, opportunities for the children of the top 1 percent are not the same as they are for the 99 percent.

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This is hardly a shock, but it is precisely the type of inequality that reveals the elusive promise of the “Just Do It” version of the American dream and deepens our cynicism about how people get ahead. As a consequence, it dilutes support for public policies that could address the lack of upward mobility among children born at the bottom, who ought to be given priority. A strong tie between adult outcomes and family background rubs Americans the wrong way. When the Pew Charitable Trusts conducted a nationally representative poll asking about the meaning of “the American dream,” some typical answers included: “Being free to say or do what you want” and “Being free to accomplish almost anything you want with hard work;” but also “Being able to succeed regardless of the economic circumstances in which you were born.” This is exactly the reason that “the American dream” is not only a defining metaphor for the country, but also why Americans have long been willing to tolerate a good deal more economic inequality than citizens of many other rich countries. A belief in the possibility of upward mobility not only morally justifies inequality as the expression of talents and energies, but also extends a promise to those with lower incomes. After all, why would you be a strong advocate for reducing inequality if you believe that you, or eventually your children, were likely to climb the income ladder? Hard work and perseverance will always be ingredients for success, but higher inequality has sharply tilted the landscape and made having successful parents, if not essential, certainly a central part of the recipe. A child’s prospects are actually more fluid elsewhere, not just in the most equal countries, like Denmark or Sweden, but even in countries like Canada that have moderate levels of inequality, as I demonstrate in a forthcoming paper in the Journal of Economic Perspectives. American children raised at the top, and at the bottom, are more likely to land on the same rung of the income ladder as their fathers than their Canadian counterparts. More than one-quarter of sons raised by fathers in the top 10 percent stay in the top 10 percent as adults, and another quarter fall no further than the top third. Meanwhile, half of those raised by fathers in the bottom 10 percent remain at the bottom or rise no further than the bottom third. In Canada there is less stickiness at the top, and children raised in the bottom are more likely to rise to the top half in earnings. Maternal income was left out of this study and others like it because many women were out of the workforce in past generations. This may have made sense once, but no longer. The achievements of the next generations reaching adulthood will reflect the steep rise in the number of working mothers as well as the increasing tendency of high earners to marry each other. Both these trends have raised family incomes in a way that will reinforce privilege and position. BUT American parents with high aspirations for their children are not packing their bags for Denmark, or even crossing the Canadian border, particularly if they find any appeal in Jann Wenner’s belief in the virtues of talent and energy. Children, after all, inherit a good deal from their parents: height, beauty, personality, to saying nothing of drive, discipline and perhaps even charm. It should be no surprise that a parent’s and a child’s incomes are correlated if certain genetic traits or aspects of family culture continue to be as important for success now as they were a generation ago. The relatively small and homogeneous Danish population can hardly be compared to a large and ethnically diverse country like America: perhaps there are just fewer

295 visionary and driven entrepreneurs on the coasts of the North Sea who have equally talented children? The belief that talent is bred in the bone, and that opportunities are open to anyone with ambition and energy, also has a dangerous corollary. When the lens of public policy is focused on the plight of the poor, this belief can help revive the laissez-faire conception of the poor as “undeserving,” the authors of their own predicament. Yet we actually know a good deal about why children of the poor have a higher chance of being stuck in poverty as adults. The recipes for breaking this intergenerational trap are clear: a nurturing environment in the early years combined with accessible and high-quality health care and education promote the capacities of young children, heighten the development of their skills as they grow older, and ultimately raise their chances of upward mobility. Talent is nurtured and developed, and even genes are expressed differently depending upon environmental influences. It is not just demography and inbred entrepreneurial spirit that make the tie between parent and child incomes stronger in America than any other rich country to which it is commonly compared. Differences in public policies also play a role. Less inequality makes opportunity-enhancing policies that are of relatively larger benefit to lower- income families easier to introduce and sustain. Ontario, the most populous Canadian province, is introducing full-day kindergarten, accessible to all 4- and 5-year-olds, without fanfare or a hint of the kind of rhetorical rancor and calamitous opposition that the Obama administration has faced for its proposal to do the same. THE Danish and Canadian top 1 percent certainly have their share of privilege: the Gus Wenners of the world, talented or not, are not rare. A recent study published by the Russell Sage Foundation showed that about 30 percent of young Danes and 40 percent of Canadians had worked with a firm that at some point also employed their fathers. This is more likely the higher the father’s place on the income ladder, rising distinctly and sharply for top earners. In Denmark more than half of sons born to the top 1 percent of fathers had worked for an employer for whom the father also worked, and in Canada the proportion is even higher at nearly 7 of every 10. This is on a par with the United States, where, according to a 2006 study, up to half of jobs are found through families, friends or acquaintances, with higher wages being paid to those who found jobs through “prior generation male relatives” who actually knew the potential employer or served as a reference. The difference is that Danes, Swedes and even Canadians are able to promote mobility for the majority while continuing to live with a dynasty at the top. It is the lack of a cleareyed focus on the top, free from rhetoric about talent and the pursuit of dreams, that is keeping Americans from effectively promoting upward mobility. This intergenerational transmission of employers has little to do with the exceptional talent that produces the next Steve Jobs. There is more than a one-in-three chance that newly appointed C.E.O.’s of American family firms will have a family connection. Yet these firms are more likely to experience a subsequent decline in performance than those promoting from outside. Family members do not on average have a distinctly more valuable set of skills or managerial talent, but the belief that they do remains an important thread running

296 through the American dream and sustains the aspirations of Americans in, roughly speaking, the top fifth of the income distribution. The 1 percent are an important touchstone for these upper-middle-class families, who after all have also experienced significant growth in their relative standing. The graduate and other higher degrees that they hold, and for which they exerted considerable effort, have put them on the upside of the wave of globalization and technical change that has transformed the American job market. An era of higher inequality gives them both more resources to promote the capacities of their children, and more incentive to make these investments since their children now have all the more to gain. It is not unreasonable for these aspiring families to believe that with a little more effort they may yet cross the threshold into the top 1 percent, and they can certainly imagine that their children stand just as good a chance, if not better. For them, an American dream based on effort, talent and just deserts still lives, and as a result they are likely to be less and less predisposed, with their considerable cultural and political influence, to support the recasting of American public policy to meet its most pressing need: the prospects of those at the bottom. Miles Corak is a professor of economics at the University of Ottawa. http://opinionator.blogs.nytimes.com/2013/07/20/whos-your- daddy/?partner=rss&emc=rss&wpisrc=nl_wonk_b

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July 20, 2013 Wealth Taxes: A Future Battleground By TYLER COWEN IF you’d like to know where American political debates are headed, the data suggest a simple answer. The next major struggle — in economic terms at least — will be over whether taxes on personal wealth should rise — and by how much. The mathematical reality is that wealth is becoming more important, relative to income. In a new paper, “Capital Is Back: Wealth-Income Ratios in Rich Countries 1700-2010,” Professors Thomas Piketty and Gabriel Zucman of the Paris School of Economics have performed the heroic task of measuring wealth for eight leading economies: the United States, Canada, Britain, France, Italy, Germany, Japan and Australia. Their estimates reveal some striking trends. For instance, wealth accumulation in these eight countries has risen relative to yearly production. Wealth-to-income ratios in these nations climbed from a range of 200 to 300 percent in 1970 to a range of 400 to 600 percent in 2010. Behind the changing ratios is some bad news, namely that slow productivity growth and slow population growth have depressed income growth, but also some good news — that relative peace and capital gains have preserved wealth. Focusing on the wealth of economies lets us reframe our recent debates about government debt in useful ways. A look at the ratio of debt to gross national product, for example, can be scary, but the ratio of debt to wealth is far less forbidding. If, say, a nation’s debt-to-G.D.P. ratio is 100 percent — often considered a dangerous level — and national wealth is 10 times yearly national income, the debt-to-wealth ratio is thus 10 percent, which is comparable to owing $100,000 on a $1 million home. Not so scary. Using the wealth numbers provided by Professors Piketty and Zucman, we can understand how Japan, despite a debt-to-G.D.P. ratio of more than 200 percent, can maintain low interest rates; Japan has a wealth-to-income ratio of about 600 percent. In essence, creditors think the Japanese political system will be able to drum up enough support for the requisite taxes, pulled out of national wealth if necessary, when the time comes. But don’t relax too quickly, because fiscal problems remain very real for many countries. While virtually every government could pay off its debts by taxing wealth, such taxes are often politically unacceptable. In other words, fiscal problems are best regarded as problems of dysfunctional governance. In the recent elections in Italy, the incumbent government lost voter support partly because it addressed the nation’s revenue problems by levying a wealth tax on real estate; the policy remains contentious and may yet be repealed or limited. And here is a related issue: If there is enough national wealth to pay off debts, it may be harder to arrange bailouts from outside. In the European Union, countries like Germany may regard the union’s more troubled nations as shirking their fiscal duties, and that makes cooperation harder to achieve. Italy, for instance, is in a fiscal crisis, but it also has an especially high wealth-to- income ratio, at 650 percent, indicating that it could pay off its debt if more of that

298 wealth were taxed. Germany, by contrast, has a much lower wealth-to-income ratio: 400 percent. And though the professors caution that the German data, in particular, may be incomplete, the figures do lend support or at least plausibility to the recent argument that Germany shouldn’t be viewed as the rich uncle of Europe. Some forms of wealth taxation take hidden forms, such as financial repression. This occurs when a nation’s citizens are required to hold deposits in banks under unfavorable terms — meaning at low interest rates. The banks, in turn, may be required to buy government debt to help finance a budget deficit. For better or worse, this is likely part of a longer-run resolution of fiscal problems in the periphery of the euro zone. In the United States, wealth taxes are currently limited to a few levies, such as property taxes and inheritance taxes. Capital gains taxes that aren’t indexed to inflation also serve as an implicit wealth tax, because they dig into the body of a person’s capital. Most likely those rates will rise. Like the bank robber Willie Sutton, revenue-hungry governments go “where the money is.” The coming battles over wealth taxation may prove especially bitter and polarizing. Most wealth has already been subjected to income and other taxes, perhaps multiple times. It doesn’t seem fair to the holders of that wealth to suddenly pay additional taxes on assets that they thought were in the clear, and such taxes would signal that previous policy has failed. Higher wealth in a nation means that there is more to take, and growing inequality means there are more problems that its government might seek to remedy. At the same time, however, this new economic configuration will mean greater political influence for the holders of that wealth, and that will make higher wealth taxes harder to achieve. Historically, economists — including me — have generally favored taxes on consumption, on the grounds that they would do the least damage to long-term savings, investment and economic growth. Yet in some eyes, rising wealth will become a tempting target for short-term political gain. And note that while most Republicans currently oppose consumption taxes, they may dislike the relevant alternative, namely wealth taxes, even more. Get ready to choose a side. Tyler Cowen is a professor of economics at George Mason University. http://www.nytimes.com/2013/07/21/business/wealth-taxes-a-future- battleground.html?src=rechp&wpisrc=nl_wonk_b

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ft.com GlobalEconomy US Economy

July 22, 2013 3:09 am Obama to start new offensive on economy By Richard McGregor in Washington

©AFP US President Barack Obama will this week begin laying the groundwork for a new battle with Republicans over the budget with the launch of a series of speeches on the economy. After months in which domestic policy has been focused on issues such as guns, immigration and health reform, Mr Obama will travel to Illinois on Wednesday to make the first of a series of speeches on the economy. More ON THIS STORY/ US economy Fiscal fallout/ White House gets tough on debt ceiling/ Obama in fresh move on immigration reform/ Changes to US healthcare law raise alarm/ US deficit expected to shrink to $759bn ON THIS TOPIC/ On Wall Street Balance tilts in favour of equities/ Moody’s lifts threat to US triple A rating/ Jack Lew The world can learn from the US recovery/ US housing construction slides to 10-month low IN US ECONOMY/ No money, but no one wants a haircut/ City of Detroit files for bankruptcy/ Bernanke offers olive branch to Wall St/ US inflation creeps nearer to Fed target White House officials said Mr Obama would announce new policies, or mount fresh pushes, on familiar issues such as manufacturing, jobs, housing and college affordability and education, as well as selling the health overhaul. But the broader aim will be to buttress public opinion for the arguments he will take into his next showdown with the Republicans over fiscal policy. The US hit its statutory borrowing limits earlier this year. The US Treasury has since taken measures to manage the US debt, but these are expected to run out around October when Congress will need to raise the country’s debt ceiling again. A confrontation over raising the debt ceiling in August 2011 brought the US to the edge of sovereign default and prompted a credit downgrade. Although the budget deficit is now coming down because of tax rises and a steady if unspectacular recovery, a similar clash could drain confidence as it did two years ago. Dan Pfeiffer, Mr Obama’s senior adviser, said the president believed “Washington has largely taken its eye off the ball on the most important issue facing the country”.

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“Instead of talking about how to help the middle class, too many in Congress are trying to score political points, refight old battles and trump up phoney scandals,” he said. “In a couple of months, we will face some more critical budget deadlines that require Congressional action, not showdowns that only serve to harm families and businesses, and the president wants to talk about the issues that should be at the core of that debate.” John Boehner, the Republican house speaker, on Sunday said the country’s fiscal position was “the biggest threat to the future of our country”, a sign he will take a hard line into the budget talks. In the past, Republicans in the House of Representatives, where the party has a majority, have insisted that hikes to the debt ceiling should be offset by countervailing cuts to public spending. “I would argue the president’s policies are getting in the way of the economy growing, whether it’s Obamacare, or all these needless regulations that are coming out of the government,” he told CBS television. Mr Boehner’s speakership has been criticised for passing little legislation but he said this was the wrong measure by which to judge activity in Congress. “We should not be judged on how many new laws we create. We ought to be judged on how many laws we repeal,” he said. http://www.ft.com/intl/cms/s/0/c72d0c5a-f26e-11e2-afd8- 00144feabdc0.html#axzz2ZlHBlKkT

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Daily Morning Newsbriefing July 22, 2013 Saccomanni discusses sale of state stakes Fabrizio Saccomanni hinted his government may sell stakes in oil company Eni, energy producer Enel and defence contractor Finmeccanica, or use the assets as collateral, according to Bloomberg. He later appeared to retract the statement, as his office said there were no concrete plans – so we should assume that this issue is hugely controversial, and very likely to be blocked by the PD. One of the ideas muted is to use the stakes as collateral for a debt reduction scheme. He said the goal was to formulate a debt-reduction scheme by the end of the year. The Italia state’s stake in those three companies is around 30% each. In an od-ed in Il Sole 24 Ore Fabrizio Forquet recalled various privatisation discussions in the past, which all ended up nowhere. But this time, the issue is more pressing. Enrico Letta has asked Saccomanni to draw up a number of options for him to consider in the autumn, which may include the railways, postal services, and even the RAI television. But Forquet says that such a kaleidoscopic administration as Letta’s will not overcome the resistance by trade unions and the Left who “for decades have looked to these companies as assets to be protected.” He says there are over 4000 such companies, mostly mismanaged, corrupt and politicised. In a sign of rising economic tensions, Italian doctors have gone on a one day strike. Emergency services will work in Italy today, but the health unions have called for a strike of 115,000 doctors and veterinary staff, and technical workers in protest rates wage cuts, freezes on hiring, job insecurity and criminal liability, Il Corriere della Sera writes. Silva decides Portugal’s government should stay full term After all the fuss president Cavaco Silva decided the coaltion government should stay in power for the full term “with reinforced guarantees of cohesion and solidity of the coalition”. Talks between the three parties collapsed on Friday as the Socialists pulled out of the meetings saying the government parties rejected most of their proposals to end the austerity policies and renegotiate the terms of the bailout. In a televised address, Silva said the coalition had presented him "guarantees of a solid understanding" on how to successfully complete the bailout programme and allow Portugal to return to full market financing. Diario Economico reports on the conditions the president attached: The governing parties must engage with Socialists, economic and social partners and they must secure approval for the 2014 budget; priority should also be given to measures for economic growth and job creation (suggesting a firmer stance of the government towards the troika according to Jornal de Negocios); and both coalition parties need to have a clear and solid partnership to successfully complete the Financial Assistance Programme. In a clear warning to the government that he will act otherwise if the coalition shows any signs of rupture, Cavaco Silva threatened with the possible dissolution of Parliament.

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The president was accused on many fronts as the one who made the crisis worse, according to Jornal de Negocios. The failure to reach a cross-party deal makes it increasingly likely that Portugal will need a second bailout when its current rescue runs out in mid-2014, writes the FT. Rajoy to appear in Spanish parliament "when he sees it fit" The People's Party line on the threat of a motion of no-confidence against Mariano Rajoy has become that the PM will appear in Parliament "when he sees it fit", and neither forced by the political opposition nor, more importantly "at the whim of the court strategy of someone who's imprisoned on corruption charges". All of this, of course, not from Rajoy himself who is still not talking to the press, but from foreign Minister José Manuel García-Margallo (who told Europa Press Rajoy will "reassure public opinion" in due course), in an ABC interview with PP parliamentary spokesman Alfonso Alonso, or Deputy PM Soraya Sáinz de Santamaría and Justice Minister Alberto Ruiz-Gallardón in the press conference after the weekly Council of Ministers as reported by ABC. All are unanimous in dismissing suggestions that Rajoy might step down or call early elections. If Rajoy is moved to react it will be because of foreign pressure. Government and PP spokespeople take comfort in the fact that the recent intensification of the Bárcenas scandal has not visibly affected Spain's standing in the capital markets or the risk premium of its debt. OECD concerned about Spain's lack of international bribery enforcement El Confidencial carries an OECD report criticising Spain for not enforcing anti-bribery legislation: "the Working Group has serious concerns that, almost 13 years after the entry into force of Spain’s foreign bribery offence, no individual or company has ever been prosecuted or sanctioned for this offence". Spain is not the only OECD country about which the OECD working group has "serious concerns" (among Eurozone countries: France, the Netherlands and Slovakia), but the report comes at a time when the Spanish published opinion is itself concerned about the foreign image of Spain being damaged by high-profile corruption cases. In a widely publicised interview by EFE (via El País) the incoming Rector of the prestigious Jesuit university of Deusto worries that "Spain is seen as a banana republic" abroad. Chinese immigrants to Spain return home In a profile of the immigrant Chinese community in Spain El Confidencial reports that Chinese immigration turned to net emigration in 2011. Chinese businesses, typically restaurants and low-cost retail, withstood the initial stages of the recession better than others due to their lower costs and wider opening hours, but the depth and length of the recession is beginning to affect them as well. Increasing numbers of Chinese immigrants are either moving to other countries or returning to China. The paper also writes that the profile of the Chinese community has been negatively affected by the so- called 'Emperador' (Emperor) case, a high-profile tax evasion case involving a wealthy Chinese businessman who used his import-export operations to aid money laundering by Spanish VIPs. French banks could get €50bn of their savings back France's state lender Caisse des Depots will return to banks €30bn of deposits banks are obliged to hold against their savings accounts, the Finance Ministry confirmed on Friday after a long awaited meeting between President Francois Hollande and senior

303 bankers. Les Echos writes that banks could get another €20bn in autumn if lending to small and medium enterprises recovers sufficiently. In France banks are required to hand over to the Caisse des Depots (CDC) 65% of the money deposited by savers on tax-free Livret A accounts for investment in public projects, Reuters explains. The popular accounts, which offer savers generous interest rates, provide the government with a source of investment that does not add to the budget deficit or public debt. The Socialist government has been pushing savers to use these accounts by raising the maximum amount they can deposit in them. Banks have complained that the move would drain more funds away from other investments and life insurance schemes just when they are being buffeted by the euro zone debt crisis and are under pressure to improve their capital ratios. Austria to inject another €700m into Hypo bank Austria will inject another €700m into nationalised bank Hypo Alpe Adria, which expects a loss for the first half of the year, according to Reuters. The bank said the extra state aid, for which the government has already budgeted, would enable it to meet its capital requirements after writing down assets which it has been unable or slow to sell as part of a restructuring. Hypo, which was nationalised in 2009, the Austrian government has since pumped more than €2bn. Hypo is expected to hive off its toxic assets into a "bad bank", but not until after national elections in September. EU banks still pose systemic threat Christopher Thompson cites an RBS study in the FT according to which European banks need to shrink their balance sheets dramatically to be able to withstand another financial crisis – putting the number of required balance sheet shrinkage at €2.7tn by 2016, from €33tn currently (note, this number refers to the EU as a whole). The article quotes an analyst as saying that governments will not be able to support their banks if the assets are three times the size of the economy. Since mid-2012, banks have reduced their balance sheets by €2.4tn since mid-2012. While deleveraging is necessary, the optimal speed is critical. At present, the periphery was delivering too fast, while the core is not deleveraging much, according to RBS. Steinbrück on joint liability The SPD has had a lousy election campaign so far. The only area where they actually managed to corner the Merkel government has been the spying scandal, where Merkel and her interior ministers are clearly, and clumsily on the defence. But in the euro crisis policy, the attacks of Peer Steinbruck have led nowhere. Steinbruck has once again come out and attacked Merkel of covering up the huge costs the eurozone crisis will cost. He says that OSI for Greece will costs the German taxpayer billions. In an interview with Wirtschaftwoche (hat tip Reuters), he is quoted as saying: "As such, the illusion about not being a union of joint liability would burst like a bubble - possibly even before the federal elections." He said it could not be excluded that other countries might need financial assistance. Some good news from the G20: No fiscal compact Most of the communique of the St Petersburg meeting of G20 is meaningless waffle, and the usual ex post rubberstamping of politics currently undertaken, but it is clear that the G20 won’t accept a fiscal straight-jacket as proposed by Germany. As opposed to a single numeric deficit and debt target for everybody, there will be country-specific

304 medium-term fiscal strategies, to be prepared for the St. Petersburg summit. FAZ cannot contain its disappointment, which it expresses in an editorial, accusing the US having sabotaged this goal. The only thing that remains of note, it said, is the co-ordination on tax fraud, and tax avoidance. Why Greece might choose to exit In his FT column, Wolfgang Munchau argues that Greece is getting closer to the moment when an exit becomes economically feasible as the country is about to achieve a primary surplus. Munchau says there was no alternative to a programme of austerity and structural reform, no matter which future scenario one envisages for Greece. Austerity and reform were simultaneously a pre-requisite for Greece to remain in the eurozone, and also for Greece to leave. In the absence of labour market reforms, any gains from a devaluation would be quickly eaten up by higher inflation. Munchau concludes that an exit is not necessarily probable, or desirable, just because the economic conditions for an exit are in place. There may be overriding political reasons to stay in the eurozone. But the feasibility of an exit may change the debate in Greece. McHale on Mody Writing in the Irish economy blog, John McHale discusses a comment by Ashoka Mody, who said on Irish radio that austerity had been self-defeating. McHale says he cannot see how the evidence in the Irish case bears this out. He says a self-defeating is not one that lowers growth, but one that does not improve the fiscal position. He classifies the self-defeating propositions into three arguments: a strong form that relates to the underlying primary deficit, the semi-strong form that relates to the debt-to-GDP ratio; and a weak form, relating to credit worthiness. Mody’s focused on the semi-strong form. McHale goes through all three, and shows that none of them hold, including the weak form, as Ireland’s bond yields have fallen. As for the first version, he cites simulation that without austerity, the underlying primary deficit would have reached 14.5% of GDP. So austerity can’t be self-defeating. All these calculations make assumptions, about multipliers for example, that may, or may not be true. We do not think that this settles the argument. If Ireland is stuck at zero growth for a decade, the adjustment policies will be looked at differently then than they are today. While the data so far do not seem to support Mody’s claim of a self-defeating adjustment, we are not yet through this. Eurozone Financial Data 10-year spreads

Previous day Yesterday This Morning

France 0.657 0.671 0.672 Italy 2.894 2.897 2.904 Spain 3.111 3.125 3.139 Portugal 5.515 5.336 5.334 Greece 8.783 8.738 8.78 Ireland 2.336 2.329 2.336 Belgium 0.978 0.997 0.999 Bund Yield 1.515 1.52 1.513 Euro Bilateral Exchange Rate

Previous This morning

Dollar 1.312 1.3146

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Yen 131.730 131.64

Pound 0.860 0.8602

Swiss Franc 1.236 1.2365

ZC Inflation Swaps

previous last close

1 yr 1.55 1.47

2 yr 1.48 1.39

5 yr 1.62 1.5

10 yr 1.96 1.84

Euribor-OIS Spread

previous last close

1 Week -5.771 -5.571

1 Month -5.143 -3.743

3 Months 0.814 2.714

1 Year 30.343 30.643

Source: Reuters http://www.eurointelligence.com/professional/briefings/2013-07- 22.html?cHash=34040a3191f38ece624fff35953d41b0

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The Irish Economy

More on self-defeating adjustment This post was written by John McHale, July 21st, 2013 at 4:20 pm Ashoka Mody offers another thoughtful perspective on Ireland’s crisis resolution effort on today’s This Week programme on RTE radio (audio here; scroll down to last item). Although he covers a good deal of ground, much of which I agree with, his main recommendation is that Ireland should consider scaling back its fiscal adjustment effort. As I note in a piece for the Business section of today’s Sunday Independent, reasonable people can disagree on the optimal speed of the adjustment given the tradeoffs involved. But Ashoka raises the old issue of the adjustment effort being self defeating. At the risk of repetition of past posts, I cannot see how the evidence in the Irish case bears this out. There is, of course, wide agreement that fiscal adjustment lowers growth. But it is a significant step from here to a claim that the adjustment is self defeating on its own terms of improving the fiscal situation. I think it is worthwhile to continue to scrutinise this claim. The self-defeating hypothesis comes in a number of forms depending on the focal outcome variable. For convenience I label the main forms as: the strong form (underlying primary deficit); the semi-strong form (debt to GDP ratio); and the weak form (creditworthiness). Ashoka’s main focus is on the semi-strong version, but it is worthwhile to briefly review the case for each. Ireland’s underlying General Government primary deficit has fallen from a peak of 9.3 percent of GDP in 2009 to a projected 2.5 percent this year. This occurred despite the massive non-austerity related headwinds the economy faced. All else equal, if there had been no adjustment from 2009, simulations show the underlying primary deficit would have reached 14.5 percent of GDP this year. The underlying actual deficit and debt to GDP ratio would have been 20.5 and 160 percent of GDP respectively. Of course, something would have given before these ratios were reached, but it is useful to consider the crude counterfactual in assessing what has been achieved. (These simulations assume a reduced-form deficit multiplier of 0.5 and an automatic stabiliser coefficient of 0.4. The underlying model being used is sketched here. ) Turning to the semi-strong form (Ashoka’s main focus in the interview), it is well known that for multipliers around unity fiscal adjustment can lead to a short-run rise in the debt to GDP ratio. The reason is that the negative effect on the denominator can swamp any positive effect on the numerator. But this static analysis can give a very misleading picture of the impact of the adjustment on the path of the debt to GDP ratio. This is most easily seen using the classic equation for the evolution of the debt to GDP ratio: ∆d = (i - g)d-1 + pd, where d is the debt to GDP ratio, i is the interest rate, g is the growth rate, and pd the primary deficit as a share of GDP. The debt to GDP ratio may rise initially due to the adverse effect on g. But the effect of this year’s adjustment on g should be temporary while the impact on the primary deficit should be permanent. The

307 permanent effect should quickly swamp the temporary effect, leading to an improvement in the debt to GDP profile as a result of this year’s adjustment. (One thing that could overturn this result is that today’s adjustment leaves a long negative shadow on the level of GDP (what is known as hysteresis), but that would again require that today’s adjustment causes the primary deficit to rise rather than fall.) Simulations for Ireland show that an additional €1 billion of adjustment in 2014 would only lead to a higher debt to GDP ratio in 2015 for values of the reduced-form deficit multiplier greater than 2.3 – above any reasonable estimate for the highly open Irish economy. Reduced austerity might well improve growth performance, but it seems highly unlikely that it would improve Ireland’s debt dynamics as Ashoka claims. Turning finally to the weak form, it is possible the direct adverse growth effects from fiscal adjustment on investor confidence could swamp any positive effect through the deficit and debt. This might happen, for example, if investors worry that the deeper recession would undermine political support for the adjustment effort. It is thus possible that despite the positive fiscal impacts, creditworthiness (as measured by secondary market bond spreads) might deteriorate. This is ultimately an empirical question. But the fall in Ireland’s 10-year bond yield from 14 percent in mid 2011 to below 4 percent today hardly suggests that Ireland’s fiscal adjustment effort has been self-defeating on even this weak definition. This entry was posted on Sunday, July 21st, 2013 at 4:20 pm and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site. 57 Responses to “More on self-defeating adjustment” 1. OMF Says: July 21st, 2013 at 4:58 pm This is most easily seen using the classic equation for the evolution of the debt to GDP ratio: ∆d = (i - g)d-1 + pd, where d is the debt to GDP ratio, i is the interest rate, g is the growth rate, and pd the primary deficit as a share of GDP. The debt to GDP ratio may rise initially due to the adverse effect on g. But the effect of this year’s adjustment on g should be temporary while the impact on the primary deficit should be permanent. The permanent effect should quickly swamp the temporary effect, leading to an improvement in the debt to GDP profile as a result of this year’s adjustment. Not to be rude about it, but you are completely wrong here– mathematically. The equation ∆d = (i - g)d + pd, as a first order linear ode with constant coefficients, has the fundamental solution d=C*exp((i-g)*t)-pd/(i-g) The primary deficient only comes into this solution as the constant particular solution pd/(i-g). The equation is in truth dominated by the exponential term c*exp((i-g)*t), which swamps all other effects. Allowing the rates to vary across time (without changing sign) does not alter the fundamental character of the solution. And the dominant part of this exponential term is the rate (i-g). This and only this term is of any interest in the long term. Changes in the primary deficient —

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positive or negative — are ultimately transient in the face of exponentially growing debt. 2. DOCM Says: July 21st, 2013 at 5:19 pm Having read the article earlier in the day, the sentence that struck me as best summing up the situation is that the Government “must tread a narrow path between supporting spending and securing its ability to borrow. This ability to borrow is in the end critical to being able to phase the adjustment over time”. The players on the pitch are,in reality, in no particular order, (i) the troika (ii) the relevant DOF, NTMA and CB officials - who have now,hopefully, gained the necessary expertise - and (iii) the markets. The politicians would like to get back into the game. While this would be desirable in terms of democratic values, it is doubtful whether the country can, literally, afford it at this critical juncture. As the SBP put it in a two-page spread today; “Twelve important things that mattered while everyone was watching the abortion debates …”. Maybe the political class can keep up the pursuit of pointless discussion a little longer. The country needs it! And, on the evidence, can afford this particular luxury. 3. John McHale Says: July 21st, 2013 at 5:24 pm @OMF You appear to miss the fact that the debt/GDP stabilising primary surplus is ps* = (i - g)d, where ps* is -pd*. For primary surplus levels (as a share of GDP) above this level, the debt/GDP ratio falls exponentially rather than rises. Now the actual equation should also include various stock-flow adjustments. A key adjustment at present is for the build up and run down of cash balances. Taking into account these effects, the debt/GDP ratio for Ireland is projected to peak this year and then fall. Of course, these are just projections, and time will tell what actually happens. But the level of the primary balance is critical to the outturn. It is true that the system is unstable for a constant primary surplus. It rises exponentially if above the critical level and falls exponentially if it is below it. In reality the primary balance will adjust over time, with greater room to reduce it as the debt/GDP ratio falls. But it is nonsense to suggest that the level of the primary balance is irrelevant to debt/GDP ratio dynamics. 4. Paul Ferguson Says: July 21st, 2013 at 7:34 pm I read posts like this with great interest and I do my best to be hopeful that the various equations produce outcomes which are likely and reasonable. And then I take a look at a graph of the money supply going back 5 decades and I can’t help but conclude that this is a very unique recession and all bets are off as we witness the end of the current system of money creation/destruction which cannot be sustained. For prior to the 1960s a much higher proportion of the money supply existed as publicly created cash issued without a matching debt. 309

When we developed computers the electronic money supply grew exponentially, doubling about every decade. All of this electronic money has a matching debt and is deleted as debts are repaid and so today’s business world is fundamentally very different from that of the 1960s. It seems a ‘decade doubling’ of the money supply is what’s needed to keep this system somewhat fit for purpose but such a rate of expansion is unfeasible for the foreseeable future, not least because mortgages have approached their natural limit of duration in taking two incomes around 30 years to repay. I think the current crisis will only be resolved when the central banks create some electronic money for their Governments which doesn’t come with a matching debt. And as such this is a very unique recession, the end of which cannot be predicted by referencing previous ones. 5. OMF Says: July 21st, 2013 at 7:44 pm I didn’t suggest it was irrelevant. I said that in the long run what matters is the rate (i-g). If growth remains below the interest rate forever (or until 2020 or whatever movable figure the government is suggesting now), then deficits/surpluses will become irrelevant and Ireland is heading for an inevitable default. Maybe i-g will suddenly become negative, but I am extremely skeptical of this happening. http://www.irisheconomy.ie/index.php/2013/07/21/more-on-self-defeating-adjustment/

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Rival accuses Germany's Merkel of deceit over euro zone bailouts Sat, Jul 20 2013 BERLIN, July 20 (Reuters) - Germany's main opposition leader Peer Steinbrueck accused Chancellor Angela Merkel of covering up the likelihood that German taxpayers will have to fund further euro zone bailouts due to a looming election. Steinbrueck, who is lagging Merkel in the run-up to the Sept. 22 vote, was quoted by a German magazine on Saturday as saying a fresh writedown on Greek debt would mean losses for public creditors, in other words taxpayers. "As such, the illusion about not being a union of joint liability would burst like a bubble - possibly even before the federal elections," Steinbrueck told Wirtschaftswoche. He added it could "not be excluded in any way" that other countries might need further financial help after the election. Many debt experts believe Europe will have to write off some bailout loans to Greece if the country is to make a successful return to capital markets. The International Monetary Fund said last month Athens may require additional debt relief as early as next year, although it did not specify what the relief might look like. Merkel and her government have in recent weeks repeatedly ruled out a further writedown of Greek debt. An open debate about loan losses could damage Merkel in the run-up to the vote. She is tipped to win a third term, in part because voters believe she has shielded them from such losses during a debt crisis that first erupted in Greece in late 2009. Private owners of Greek debt were forced to swallow significant losses on their holdings last year, but European governments and the European Central Bank, which bought up Greek bonds at the height of the crisis, have refused to take a hit. Germany has insisted a writedown of Greek debt held by euro zone governments would be illegal, although Finance Minister Wolfgang Schaeuble suggested late last year that such losses might be considered once Greece achieves a primary surplus. (Reporting by Sarah Marsh; Editing by Mark Potter) http://www.reuters.com/article/2013/07/20/eurozone-germany-spd- idUSL6N0FQ0EW20130720

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ft.com comment Columnists July 21, 2013 8:32 pm A Grexit is starting to look more feasible for Athens

By Wolfgang Münchau For Greece to reform and not default makes sense only from Berlin’s perspective

©AFP I would like to ask all of you not to continue at this time this discussion on a new haircut ... It is not in your interest.” So said Wolfgang Schäuble in Athens last week. I do not blame Germany’s finance minister for refusing to discuss a Greek debt write-off at this time. His country’s federal election is only two months away. Given Berlin’s approach to crisis resolution, I struggle to think of a more certain way to lose the vote than to say: “All right, then, let’s start to be realistic right now.” More ON THIS STORY/ Schäuble on ‘confidence’ trip to Greece/ Greece’s civil service cull heralds break with the past/ Greece agrees deal to reform civil service/ Greece secures €4.8bn bailout tranche ON THIS TOPIC/ Greece close to averting bailout crisis/Greece faces second sell-off collapse/ Markets Insight Greece shows need for bankruptcy code/ Samaras reshuffles Greek cabinet WOLFGANG MUNCHAU/ The dangers of Europe’s technocrats/ Guidance only works if you do it right/ The EU will regret terminating a banking union/ Europe is ignoring the scale of bank losses But Mr Schäuble went a step further in his remarks by raising the Greek national interest. It is, of course, for the Greeks themselves to define their own interest.

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The most one could do as an outsider would be to try to speculate about a narrower version of this question: would it be economically rational for Athens to follow the path outlined by Mr Schäuble? Alternatively, should it get ready to leave the eurozone? Or try to default inside the eurozone? The main difficulty one encounters when answering the question is the underlying assumptions about the nation’s future policy options. It may well be that the Greek government has received unofficial assurances that do not correspond to what the rest of us know. In private conversations with policy makers, I only rarely encounter someone who tells me with a straight face that Athens could stabilise its economy at full employment while happily servicing its current debt in full. Maybe the Greek prime minister has private information that the eurozone would agree to debt restructuring after all, further extensions of the existing loans, further reductions in interest rates, a combination of all three and more. The rest of us, however, would have to assume that future policy is close to Mr Schäuble’s version. Assessing the narrower economic preconditions for an exit is easier. A country would find it hard to stage a unilateral exit from a monetary union if its primary fiscal balance – before payment of interest – was in a substantial deficit. In its latest spring forecast, published in May, the European Commission estimates a zero primary fiscal balance for this year and a primary surplus of 1.8 per cent of gross domestic product for 2014. From an economic point of view, the point at which Greece could risk an exit is certainly getting closer. If Greece were to depart, it would be cut off from external funding. It would presumably not service its foreign debt, at least for a while. It would then introduce its own currency during an enforced bank holiday period. There would almost certainly be a recession in the ensuing period, but a real depreciation could bring back growth in the future. The single largest benefit would, at least initially, come through a boom in tourism. But would this be enough? Can we be sure of it? The biggest economic argument against an exit in the past, quite apart from the funding problem, has been the almost total lack of an upside. The country did not have a functioning system for tax collection. Labour market cartels meant that the perceived benefits from a nominal devaluation may never have come about. The immediate gain in competitiveness would have been absorbed by wage increases, leaving the real exchange rate unchanged. So one needs to ask to what extent past and present reforms have altered the robustness of the economy. My hunch is that they have done so, especially in the way the public sector works, but more is probably needed. My criticism of eurozone policy towards Greece is not the harshness of the adjustment but its fundamental macroeconomic illiteracy. At its heart lies the delusion that Greek debt could be rendered sustainable. But the reforms – and, yes, the austerity as well – were inevitable. There is an irony in this. Reforms and austerity constitute simultaneously a precondition to stay in the eurozone, and a precondition for a departure. This leaves Greece with two options. The first is to reform and default inside the eurozone – a strategy that requires willing accomplices in other European capitals and in the European Central Bank. The second is to reform and default outside the eurozone – a decision Greece could take unilaterally, provided the macroeconomic conditions are right.

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The second has not been possible – until now. But Mr Schäuble’s option of reforming and not defaulting makes sense only from his point of view. It is not an option for Greece. Of course, the realisation that a departure from the eurozone may be economically feasible, or even advantageous, may count for nothing. A country may decide to stay inside the eurozone for political or security reasons. But surely we are at a different stage of debate when an exit becomes economically viable. That has not been the case so far. Not for Greece, nor for any of the other countries in crisis. And when there is real choice, outcomes become harder to predict. http://www.ft.com/intl/cms/s/0/0d0ee174-f05f-11e2-b28d- 00144feabdc0.html#axzz2ZlHBlKkT

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ft.com Companies Financials Banks July 21, 2013 8:32 pm Banks need far more structural reform to be safe By Michael Barr and John Vickers Services upon which people depend should be better protected, say Michael Barr and John Vickers

©EPA On the third anniversary of the passage of the Dodd-Frank Act, banking reform remains a work in progress across the world. In the US key provisions of the law, including the Volcker rule to limit proprietary trading, have still to be implemented and the authorities only recently published new rules on capital standards. In the EU, last month’s agreement by finance ministers on rules to govern what happens in the case of bank failures was an important step but many questions remain. And on both sides of the Atlantic, much more needs to be done on a fundamental issue – the structure of banking entities. This is crucial for three reasons. First, having a clear sense of who is in charge of what is vital when it comes to management and supervision, especially in times of stress. Structural reform and “living wills” can be used to help clarify lines of authority, align business risk with organisational form and simplify structures of complex financial institutions. More ON THIS STORY/ EU banks still pose systemic threat/ John Gapper Regulators are closing in on banks/ Bond yields threaten bank balance sheets/ Wolfgang Munchau Europe is ignoring the scale of bank losses ON THIS TOPIC/ Italian bank puts loan package on sale/ EU banks warn on regulation impact/ Euro banks cut cross-border debt holdings/ Bank funding tight for companies in Europe IN OPINION/ Steve Hanke and Garbis Iradian Heavier sanctions on Iran/David Davis and John McFall Diversify lending sources/ Max Hastings In defence of male-only clubs/ Welfare and the Tinker Bell policy Second, structural reform can help bolster “horizontal buffers”, which can help stop crises spreading. Limits on the activities of retail deposit banks, restrictions on transactions between retail banks and their affiliates, independent capital and caps on counterparty credit exposures can help minimise contagion. The core banking services upon which everyday economic life depends would be better protected.

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Third, paying attention to structure would help resolve companies when they get into distress. In the US, the Federal Deposit Insurance Corporation is developing a “single point of entry” model for resolution that would allow it to wind down a complex financial conglomerate by separating it into a holding company with “resolution-ready” capital and equity, and solvent subsidiaries permitted to continue to operate. Similar approaches are being pursued in Europe. Structural reform will make it much more likely that such resolution plans would work in a crisis. Indeed, it is hard to see how complex financial companies can be credibly resolved without prior measures of structural reform. But isn’t the world diverging on issues of structure, with the US, UK and the eurozone going in different directions? In a word, no. There is, in fact, growing convergence on structural reform. The US has long used the bank holding company structure to try to separate banking from other financial activities within a complex group. Recent reforms under the Dodd- Frank Act strengthened the wall between banks and other parts of a financial group, moved more dangerous derivatives activities to affiliates, and pushed proprietary trading and significant hedge fund investing outside the group entirely. In the UK, the House of Lords will this week debate legislation based on the recommendations of the Independent Commission on Banking, which will move Britain more towards the US approach of using bank holding companies with separate subsidiaries. The retail banking subsidiary would have more restricted activities and would be ringfenced from other units. Europe is considering similar reforms proposed by the Expert Group chaired by Erkki Liikanen. These proposals would separate trading and market-making from banking activities within the company. As in the US and UK proposals, bank transactions with affiliates would need to be at arm’s length and subject to quantitative caps. None of these approaches is perfect, or perfectly aligned, and all are evolving. Structural reform involves difficult trade-offs: introducing rigidity may decrease efficiency and increase the risks faced by individual banks, while reducing the potential harm done to the system as a whole. In response to these trade-offs, the US, UK and Liikanen approaches all accept that universal banking can be efficient but see the need for it to have structural safeguards. Further global progress on these measures – on structured universal banking – would be well warranted. Ringfencing by itself, of course, will not bring financial stability. We had forms of ringfencing before the crisis, as in the US, where it blinded regulators to the dangers of shadow banking. As a result, non-bank financial institutions engaged in increasingly risky activities with too little oversight and far too much leverage. So structural reforms need to be part of a broader change in supervision and capital requirements, including resolution procedures for large financial companies regardless of their corporate form, and much-needed reforms to derivatives markets. Ringfencing is no excuse to avoid regulating non-bank firms and markets that can pose a risk the financial system. At the same time, Europe should embrace structural reform as an essential feature of banking reform. And the prospect of eurozone banking union makes this all the more important.

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The writers are the former US assistant secretary of the Treasury for financial institutions and the former chairman of the UK’s Independent Commission on Banking http://www.ft.com/intl/cms/s/0/e2bc9968-e3e6-11e2-91a3- 00144feabdc0.html#axzz2ZlHBlKkT

ft.com World Europe July 21, 2013 10:14 pm Portugal’s coalition seeks to soldier on after unity talks fail By Peter Wise

©Reuters Portugal’s fragile coalition government is to remain in office and attempt to ride out the country’s political crisis after the collapse of talks on a “national salvation” pact with the main opposition party. President Aníbal Cavaco Silva said on Sunday night that he had been given “additional guarantees” from the two government parties that they would keep their coalition together to see through the country’s €78bn EU bailout programme. More ON THIS STORY/ Portugal Waiting it out/ Portugal’s woes threaten bailout exit/ Portugal pulls back from chasm edge ON THIS TOPIC/ Portuguese contagion risk contained/ Portuguese instability rattles markets/ Portuguese bond yields soar/ Portugal president’s call for national unity backfires IN EUROPE/ Froome celebrates Tour victory/ Surveillance claims cast cloud over Merkel’s campaign/Mariano Rajoy faces renewed pressure over slush fund scandal/ Riots as French police enforce burka law He ruled out calling a snap general election two years ahead of schedule, rejecting the principal demand of opposition parties to the left of the centre-right government. “An early election would not resolve our problems,” said Mr Cavaco Silva in a televised address. “The best alternative solution [to a pact] is for the current government to remain in office.” The president said the ruling coalition, which is supported by a comfortable majority in parliament, would shortly table a confidence motion setting out its economic plans until the end of the legislature in 2015. On Monday morning, the PSI 20 rose 0.6 per cent to 5,562.0, while Portugal’s borrowing costs on its benchmark 10-year sovereign debt fell 49 basis points to 6.873 per cent.

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Mr Cavaco Silva had called on the two government parties and the opposition Socialists (PS) to hammer out a cross-party pact after the ruling coalition was rocked by the resignation of two senior ministers in early July. But the PS pulled out of the talks on Friday, saying the government parties had rejected most of its proposals. The PS has called for Portugal’s bailout terms to be renegotiated to ease the impact of austerity on the recession-hit economy. The aim of a pact was to provide a guarantee that Portugal’s three mainstream parties would remain committed to the bailout programme and to keeping public deficits under control over the medium term. Mr Cavaco Silva said a cross-party agreement would have been the “best solution” for overcoming Portugal’s “national emergency” and ensuring that the country regained full access to international capital markets after concluding its rescue programme next June. Portugal had to put an end to the idea that it was “unpredictable” and “ungovernable”, he said. Portugal’s borrowing costs have surged during the past three weeks amid fears that the political crisis would bring down the government and derail the bailout programme. The failure to reach a cross-party deal makes it increasingly likely that Lisbon will need a second bailout when its current rescue runs out in mid-2014. It will also test the ability of Pedro Passos Coelho, the prime minister, to hold his centre-right coalition together in the face of deep divisions over government plans for further tough spending cuts and public sector job losses. Unlike Greece, which has also struggled to keep its bailout on track, Portugal has over the course of the past six months been able to dip back into the bond market to raise cash, including issuing new 10-year debt only two months ago. That had raised hopes that Lisbon was on its way to full self-financing when bailout funds run out in mid- 2014. But the political crisis, combined with increased opposition to austerity and huge borrowing needs in the two to three years following the current bailout, have led Portugal’s international partners to acknowledge privately that an Ireland-style exit from the three-year bailout programme is now unlikely. While analysts at Barclays Research welcomed the news, they added in a note that “important disagreements on some key policy decisions, including on the policy mix between austerity and pro-growth policies, render the government coalition fragile”. Additional reporting by Peter Spiegel in Brussels http://www.ft.com/intl/cms/s/0/a618e750-f246-11e2-8e04- 00144feabdc0.html#axzz2ZlHBlKkT

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ft.com Comment Opinion July 21, 2013 7:24 pm Diversify the sources of lending for the UK’s small businesses By David Davis and John McFall Financing smaller enterprises is not just for venture capitalists, say David Davis and John McFall I would rather see finance less proud and industry more content.” Those words were spoken by Winston Churchill almost 90 years ago, but should serve as a mission statement for our financial industry and parliamentarians today. From money laundering to mis-selling, Britain’s banking industry has failed its customers. The parliamentary commission on banking standards, set up to examine how the industry behaved, found that standards were low and the culture rotten. This reinforced the comments of Adair Turner, the former Financial Services Authority chairman, who branded much City activity as “socially useless”. More ON THIS STORY/ Banks news headlines/ Report into HBOS failure in ‘final stage’/ John Kay Don’t look for fair prices on the market/ Andrew Freeman Outdated IT could lead to banking crisis ON THIS TOPIC/ RBS accused of ‘butchering’ business/ Lex Barclays – baring its teeth/ Barclays trader ‘bragged of manipulating market’/ P-to-P investors hanker after financial basics IN OPINION/ Steve Hanke and Garbis Iradian Heavier sanctions on Iran/ Michael Barr and John Vickers Banks need far more structural reform/ Max Hastings In defence of male-only clubs/ Welfare and the Tinker Bell policy With assets worth 492 per cent of Britain’s annual gross domestic product, the banking sector is still too large to be stable. Worse still, its failure to lend threatens economic recovery. We need innovative ideas to get businesses moving without having to rely on the banks. Over the past four years we have seen a series of futile attempts to increase lending to business and stimulate the economy. Project Merlin and the Funding for Lending Scheme have had limited impact. These failures are costly. British businesses currently get 80 per cent of their finance from banks; their US counterparts raise 80 per cent of their finance through capital markets. It is no coincidence that the US economy is growing and creating new jobs while the UK lags behind. For British business to catch up we need a growth agenda that creates jobs and a diverse financing system that breaks the banks’ stranglehold on lending. New research shows how to do so. A survey by The New City Network, a think-tank, reveals that of the companies refused loans, 93 per cent only approached banks in their search for funding. By contrast, those that sought more diverse financing – from invoice discounting and mezzanine loans to

319 venture capital and private equity – were more successful. The lesson is clear: when it comes to borrowing, British business needs more options. Diversifying the financing of small and medium-sized enterprises is not just a job for experienced venture capitalists. The first and most obvious opportunity to do so lies in the £750bn of deposits idling on the balance sheets of big UK businesses. If these companies took even a fraction of this money and invested it in partnerships with SMEs and start-ups, the benefits for both sides – and the economy – could be huge. For large companies, it would bring new ideas and products to their business. For small ones, it would provide the funds required for them to grow rapidly and create jobs. There are 4.8m SMEs in the UK, employing 60 per cent of the workforce and representing 50 per cent of GDP. It is these companies, not the FTSE 100 giants, that create the most new jobs. With better access to finance they could create another 2m jobs across the UK. For small businesses, the financial crisis has made access to bank finance much more difficult. With banks facing consolidation and deleveraging, there is simply not enough money available to allow SMEs to fulfil their potential. One government review estimated that, in the next three years alone, there would be a funding shortfall of between £84bn and £191bn. This is a massive wasted opportunity. Reliance on bank finance also creates a mismatch between the risk that entrepreneurs take and that shouldered by the banks, whose incentive is not growth but a fixed return. Small, high-growth businesses often need loans before they start generating revenue, and may not be able to make regular loan repayments straight away. Partnerships between large companies and SMEs could provide the flexible funding they need. Debt can be used very successfully, and access to the bond market for more mature SMEs should not be overlooked, but we have become too focused on one type of funding and we are, as a result, in danger of failing our entrepreneurs. We urgently need to develop new, sustainable and secure sources of finance. It is time to make the financial industry less proud and our SMEs more content. Our message to policy makers is simple: diversify lending or be damned. The writers – respectively MP for Haltemprice and Howden and a member of the House of Lords – are board members of the New City Network http://www.ft.com/intl/cms/s/0/acb89d4c-efcd-11e2-a237- 00144feabdc0.html#axzz2ZlHBlKkT

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ft.com Companies Financials Banks July 21, 2013 6:27 pm Deutsche Bank set to shrink to achieve leverage target By Daniel Schäfer in London

©Bloomberg Deutsche Bank plans to shrink its vast balance sheet by as much as a fifth in order to comply with incoming stricter rules for financial soundness. In a big strategic step by Germany’s largest lender by assets, Deutsche is expected to tell investors that it aims to achieve a minimum 3 per cent ratio of overall equity to loans by the end of 2015, people briefed on the plans said. More ON THIS TOPIC/ Dismissed traders sue Deutsche Bank/ Billionaire Vik in $8bn Deutsche Bank defence/ Deutsche shareholders rebel over board/ German banks €14bn short of Basel III IN BANKS/ UBS agrees to settle US housing claims/ ABN Amro prepares for reprivatisation/ Wall St quizzed over physical commodities/ Banks’ influence on raw materials probed Such a clear timetable, likely to be announced with its second-quarter results at the end of the month, will address investors’ concerns that Deutsche Bank has one of the lowest leverage ratios of large banks globally. It is also considering issuing at least €6bn in hybrid equity capital such as convertible bonds – debt instruments that can convert into shares – once the German banking regulator has clarified which instruments will be recognised under a new global capital regime for banks. Rival bankers and analysts have long carped that Deutsche has operated at much lower capital levels throughout the financial crisis than some peers, complaints that have intensified as European competitors from UBS to BNP Paribas have drastically cut back their balance sheets. The German lender’s estimated ratio of equity to assets stood at 2.1 per cent at the end of the first quarter, the second-lowest of 18 banks ranked by Morgan Stanley analysts. European regulation based on the Basel III global rule book calls for the minimum ratio of 3 per cent to be achieved only in five years’ time. But the topic has risen on investors’ agenda after UK, Swiss and US regulators have drawn up plans for either stricter timetables or higher ratios.

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Deutsche Bank aims to trim its balance sheet by up to 20 per cent to about €1tn under US accounting rules in the next two and a half years. The bank believes the measures it is planning would have a very small impact on earnings. Its strategy to achieve the minimum ratio includes the application of new regulatory rules for the accounting of derivatives, reducing its vast cash pile of €240bn and shrinking the €90bn of assets in its so-called non-core unit, mostly non-performing loans. Analysts say investors will push for banks to reach the minimum ratio much earlier than the Basel III rules demand. “Our expectation is that most European banks will aim to meet requirements by 2015,” Kinner Lakhani, analyst at Citigroup, wrote in a note to clients. The discussion around leverage ratios has brought Deutsche Bank’s capital position back into the spotlight only months after senior managers thought the issue had been taken off the table. A year ago, the bank was seen as lagging behind in its core tier one level, the new regime’s main capital gauge that allows banks to underpin assets with different amount of equity depending on their perceived riskiness. Twelve months on and helped by a capital increase in April, the bank became the fifth- strongest capitalised lender globally with a core tier one ratio of 9.6 per cent. Analysts and bankers said there would not be a similar race to the top on leverage ratios as there had been with the core tier one ratio. “Markets will only expect a bank to achieve minimum compliance,” one European bank executive said. The focus on leverage ratios has drawn the ire of bank executives, who warned it would incentivise lenders to concentrate on riskier products and reduce cash holdings. “A leverage ratio is undoubtedly important,” Anshu Jain, Deutsche Bank’s co-chief executive, said at a recent conference. “But [it] has significant flaws that could lead to perverse outcomes.” http://www.ft.com/intl/cms/s/0/463d8f44-f092-11e2-929c- 00144feabdc0.html#axzz2ZlHBlKkT

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ft.com Companies Financials Banks July 21, 2013 12:09 pm Banks’ influence over raw materials supply chain under scrutiny By Gregory Meyer and Tom Braithwaite in New York Wall Street banks’ rise as merchants of oil, natural gas, coal and industrial metals is under threat as a US regulator revisits a string of permits for trading physical commodities issued over the past decade. Senior officials at the Federal Reserve have in recent weeks discussed with bank executives the question of whether to bar banks from owning physical commodity assets, according to people familiar with the talks. More ON THIS STORY/ Wall St quizzed over physical commodities/ Platts attacks Europe’s oil price probe/ Wall Street returns to era of big profits/ Investors flee from commodities at record pace ON THIS TOPIC/ Senior Democrat opposes tax cut for rich/ Senate approves Obama tax cut plan/ Congress moves closer to student loan deal/ Senate to take up Simpson- Bowles deficit plan IN BANKS/ UBS agrees to settle US housing claims/ ABN Amro prepares for reprivatisation/ Deutsche Bank to shrink in leverage plan/ Santander eyes peer-to-peer lending A move to curtail the freedom to ship tankers of oil or fill pipelines with gas could pressure a historically lucrative niche for banks including Barclays, Goldman Sachs, JPMorgan Chase and Morgan Stanley. JPMorgan spent $1.6bn just three years ago to acquire the global oil, metals and coal divisions of RBS Sempra Commodities in an explicit push into physical trading. US law allows banks to trade commodity derivatives such as futures contracts. In 2003, the Fed expanded this authority by granting Citigroup permission to also own the tangible oil, gas and grains underlying derivatives. Several other banks then received similar approvals through 2008. These permits are now under question. “The Federal Reserve regularly monitors the commodity activities of supervised firms and is reviewing the 2003 determination that certain commodity activities are complementary to financial activities and thus permissible for bank holding companies,” the Fed said. In another sign of mounting scrutiny, a US Senate subcommittee is scheduled on Tuesday to hold a hearing on banks’ involvement with power plants, oil refineries and warehouses. Sherrod Brown, subcommittee chairman, said: “Regulators need to take a long, hard look at the practice of banks holding physical commodities. When Wall Street banks control the supply of both commodities and financial products, there’s a potential for anti-competitive behaviour and manipulation.” Bankers say trading physical commodities helps them improve services to customers by understanding prices of thinly traded markets. Northern Tier Energy, an oil refiner, said

323 in a filing its deal to buy crude from JPMorgan “significantly reduces the investment that we are required to maintain in crude inventories”. Some senior Fed officials see different levels of threat that could be tackled in different ways, with the potential liabilities from a bank-owned oil shipment spilling in the Gulf of Mexico at one extreme. When Wall Street banks control the supply of both commodities and financial products, there’s a potential for anti-competitive behavior and manipulation - Sherrod Brown Despite complaints that prices of industrial metals have been distorted by banks’ warehousing units, there is less concern about those commodities at the Fed. Though a full-scale ban is on the table as part of the Fed’s review, it is possible that different restrictions could be put in place for different commodities, according to people familiar with the discussions. Higher and differentiated capital charges are one option. Goldman and Morgan Stanley have historically been treated differently than their rivals. The former two are allowed to own and trade around property such as power plants and oil storage tanks, a privilege grandfathered before they became Fed-regulated financial holding companies during the 2008 financial crisis. Other banks must lease such facilities or own them as arm’s-length “merchant banking” investments to be sold within 10 years. However, Morgan Stanley has warned that the Fed may require it to divest these properties as it approaches its fifth anniversary as a financial holding company. http://www.ft.com/intl/cms/s/0/5274937a-f0ba-11e2-b28d- 00144feabdc0.html#axzz2ZlHBlKkT

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ft.com Markets Capital Markets July 21, 2013 1:36 pm EU banks still pose systemic threat By Christopher Thompson Europe’s banks need to shrink their balance sheets dramatically to ensure the continent can withstand another financial crisis, according to an analysis by Royal Bank of Scotland. Eurozone banks must shed at least €2.7tn in assets by 2016 for their balance sheets to be “sustainable”, RBS economists have calculated in a research note. European bank assets and liabilities

More ON THIS STORY/ Michael Barr and John Vickers Banks need far more structural reform/ John Gapper Regulators are closing in on banks/ Bond yields threaten bank balance sheets/ Wolfgang Munchau Europe is ignoring the scale of bank losses ON THIS TOPIC/ Italian bank puts loan package on sale/ EU banks warn on regulation impact/ Euro banks cut cross-border debt holdings/ Bank funding tight for companies in Europe

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IN CAPITAL MARKETS/ Market for dim sum bonds goes cold/ US equity funds flooded with $17.5bn/ Eurozone assets head off on summer rally/ This time there is a case to buy Japan The sector’s assets are worth about €33tn currently, or nearly three and a half times the single currency zone’s annual gross domestic product. “If you have a banking crisis and banks are three times the size of their underlying economy, then governments will not be able to support them all,” said Alberto Gallo, head of European credit research at RBS. “[Europe’s banking system] is the biggest in the world and arguably too big . . . in Japan, Canada and Australia the banking sectors are about twice the size of the economy, while the US is around the same size [as the economy].” Since mid-2012 eurozone banks have reduced their balance sheets by €2.4tn according to data from the European Central Bank in Frankfurt. However, there is “at least €2.7tn more to go” according to RBS – a reduction that would bring banks’ combined assets down to about three times eurozone GDP. “For European banks there has to be a period of shrinkage,” said Vinod Vasan, head of European financial institutions’ capital markets at Deutsche Bank. “The banks need to be smaller one way or another – but if they can manage it they can also be more profitable.” But as European banks deleverage, such as by selling loan books, there are knock-on effects to the real economy. “It’s a catch-22: if you delever too much too quickly you risk going into an accelerated credit crunch. But if you don’t, you risk having a system which is problematic in the long run,” said Mr Gallo. “Today, deleveraging is happening unevenly in Europe: too quick in the periphery, too slow in the core – generating what [ECB president Mario] Draghi calls financial fragmentation.” Banks’ deleveraging has led to bond issuance by European financial institutions dropping to its lowest level in a decade. The fall also reflects the increased risks of creditors being “bailed-in” if a bank fails, following Europe’s overhaul of the way banks are rescued in the event of a default. While banks have also made early repayments to the ECB of cheap funding taken out under its crisis-fighting long-term refinancing operations, small and medium-sized businesses, particularly in countries like Spain, complain they cannot access bank finance. Combined with the continuing recession, critics suggest the banks are more focused on deleveraging than increasing the amount they lend out, which could help kick-start an economic recovery. http://www.ft.com/intl/cms/s/0/d23922de-f08c-11e2-929c- 00144feabdc0.html#axzz2ZlHBlKkT

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Economía OPINIÓN Las uvas y el vino bancarios SANTIAGO CARBÓ 21 JUL 2013 - 00:00 CET En estos meses, los Gobiernos e instituciones europeas se aferran de forma recurrente a dos ideas que encierran cierta contradicción. Por un lado, se insiste en que es preciso reactivar el crédito para relanzar la economía. Por otro lado, se expresa con la misma frecuencia una desconfianza generalizada hacia las entidades financieras. No hace demasiado, el presidente del Eurogrupo, Jeroen Dijsselbloem, reconocía en declaraciones a EL PAÍS una realidad tan directa como dura de aceptar: “Honestamente, no sabemos cómo está la banca europea”, afirmaba. Uno de los sectores bancarios sometidos a mayor escrutinio en los últimos años ha sido el español. Sucede que, poco a poco, las entidades financieras españolas han ido mostrando la magnitud de algunos desequilibrios, los esfuerzos realizados para corregirlos y los desafíos pendientes de realizar. La macroeconomía y el sector financiero se hallan estrechamente ligados, y esa unión ha sido un tira y afloja continuo para determinar cuándo se produciría la recuperación de la parte financiera de la economía, cuándo lo haría la real y en qué medida arrastraría la una a la otra. Como quiera que el desfase crediticio en los años anteriores a la crisis y el aumento del desempleo en los últimos años —como más importantes variables explicativas del deterioro bancario— han sido especialmente llamativos en España, la atención de las autoridades europeas no hizo sino aumentar y aumentar. Los esfuerzos por corregir una de las dos partes del riesgo bancario —la del desfase crediticio y sus consecuencias— han sido ingentes, pero la otra parte —la de una macroeconomía deprimida— ha permanecido y sigue amenazante. En medio de esta delicada situación, se añadió el componente adicional del riesgo soberano y, con ello, se acabó produciendo algo así como una oficialización del escrutinio externo al sector bancario español. En particular, una ayuda financiera contingente europea, que conllevó un Memorando de Entendimiento (MoU) que ha supuesto un amplio conjunto de medidas de condicionalidad para el sector bancario. Justo hasta ahora, hasta finales de julio de 2013. España las ha cumplido todas, pero algunas incertidumbres persisten. ¿Por qué? Porque el juego es dinámico. No es lo mismo arreglar un barco anclado en un puerto que en plena travesía. La situación del empleo y la actividad siguen siendo delicadas, y las mejoras previstas no invitan a lanzar las campanas al vuelo. La travesía continúa y, con ella, la necesidad de corregir cuando sea preciso. Se puede dudar del tiempo preciso para reafirmar la estabilidad, pero el problema no es español En todo caso, se puede dudar sobre el tiempo y los esfuerzos que aún serán precisos para reafirmar la estabilidad, pero el problema no es español. Incluso aunque queden aspectos por clarificar, la oscuridad sigue cerniéndose sobre los sectores bancarios al norte de los Pirineos, protegidos por el calor de una macroeconomía menos desfavorable. Hasta ahora. Sin embargo, si todo sigue igual, llegará el invierno, y todos habrán de mostrar sus fortalezas y debilidades. En parte, porque, tanto en España como en otros países del euro, el siguiente gran test será la llamada revisión de calidad de los activos (asset quality review o AQR) que realizará el Banco Central Europeo (BCE), como parte de su papel de supervisor único en el aún incipiente y farragoso proyecto de

327 unión bancaria. De hecho, la Autoridad Bancaria Europea (EBA) retrasa sus nuevas pruebas de esfuerzo hasta 2014, una vez que el BCE haya realizado su AQR, aunque están pendientes plazos y detalles. Lo que puede conseguir el AQR es un “¡todos a desnudarse!” del que ha estado lejos la EBA, que, como se ha dicho tantas veces, ha sido todo buenas intenciones, pero no ha sido ni “autoridad” —porque sus pruebas han sido objeto de duras críticas por sus lagunas metodológicas— ni “europea” —porque algunos países han presentado a examen un número limitado de entidades financieras, poco representativo. No lo tiene fácil el BCE con el AQR, pero puede que sea la realidad a la que deba enfrentarse el sistema financiero europeo. Lo que el BCE quiere, como supervisor, es lo que querría un buen bodeguero, ver bien las uvas antes de ponerse a hacer vino. Siguiendo el símil, lo que pasa en España es que con la reestructuración y la recapitalización se está completando una reforma de una bodega que tradicionalmente era de gran calidad, pero en la que las uvas necesitan madurar algo más y protegerlas de las inclemencias del tiempo (la macroeconomía). En el resto de Europa, la situación es menos conocida, y habrá uvas mejores y peores, pero lo que está claro es que muchas bodegas necesitan reformas. ¿Sacarán los AQR a relucir las condiciones de cada cual? Es muy pronto para saberlo, pero la duda planea sobre Europa. Casi seis años después. Antes del gran examen, España trata de clarificar algunas dudas ya de largo comentadas, tales como la salud de las carteras hipotecaria y corporativa y los escenarios previsibles para las mismas a medio y largo plazo. Los últimos informes de seguimiento del sector bancario español de la troika —en particular, los de la Comisión Europea y el más reciente, el del FMI— han apuntado en varias direcciones. Ya se trabaja en una nueva interpretación de los sistemas de clasificación de créditos y se persigue estimar el impacto de las refinanciaciones y del riesgo de las hipotecas y otras carteras. Tarea fundamental. Y, por supuesto, hay que lidiar con lo que queda del MoU. Implementadas todas las medidas exigidas por Europa, ahora queda gestionarlas, que es tanto o más difícil, con dos grandes retos pendientes. Uno es que la sociedad de gestión de activos Sareb acomode en mayor medida su estrategia a la evolución real que están teniendo los precios inmobiliarios. La Sareb es un actor fundamental para el ajuste inmobiliario pendiente y para determinar los costes finales para el contribuyente de la resolución de la crisis bancaria en España. Ambas cuestiones de enorme trascendencia para la credibilidad del conjunto del sistema. El otro es resolver la viabilidad y reprivatización de entidades nacionalizadas, especialmente las que han recibido el mayor montante de ayudas. Son tareas fundamentales porque de ellas dependerá, entre otras cosas, la credibilidad y afianzamiento de la estabilidad financiera en España y los costes a largo plazo que asumirá el contribuyente y que hay que minimizar. Otra cuestión que conviene zanjar cuanto antes en España —tal y como se ha hecho ya en países como Italia o Reino Unido— es la de los créditos fiscales acumulados por las entidades financieras y la posibilidad de que computen como recursos propios. Mientras no se resuelva, esta cuestión añade dudas y cuantitativamente no es desdeñable. Según diferentes estimaciones, hablamos de entre 30.000 y 50.000 millones de euros. Poco a poco, si se aclaran estas cuestiones, el sector bancario español verá la luz para enfrentarse a sus dos retos verdaderos de medio y largo plazo. El primero de ellos, reactivar el negocio, con especial atención al crédito a empresas solventes. El segundo, contar con un colchón de solvencia que mantenga alejadas las dudas sobre la solvencia del sistema. Exagerar la solvencia, si se quiere, porque un mercado global desconfiado lo exigirá aún durante años a las entidades financieras, sin importar su procedencia. Un reto al que se enfrentan, sin distinción de tamaño o naturaleza, todas las entidades 328 financieras españolas. El vino tendrá que ser bueno, pero los sistemas de seguridad de la bodega, los mejores. Así lo ha recordado también el FMI porque sabe que esa necesidad hay que hacerla virtud. Es comprensible que muchos ciudadanos españoles y europeos permanezcan atónitos a la dificultad para recuperar esa estabilidad financiera, pero esta es una crisis bancaria y es el peor tipo de crisis que se puede padecer, comprender y superar. Lo que resulta curioso es que el sector bancario español, después de andar desacompasado durante años respecto a la mayor parte de los europeos en sus esfuerzos y acciones (para mal al principio y para bien después), tiene la oportunidad de encontrarse de nuevo a un compás similar a los de su entorno en 2014, ante la foto del supervisor único. Para ello, aún hay mucho que hacer hasta entonces para lograrlo. Y el camino no es de vino y rosas. Santiago Carbó Valverde es catedrático de Economía de la Bangor Business School (Reino Unido) y de la Universidad de Granada e investigador de Funcas. http://economia.elpais.com/economia/2013/07/19/actualidad/1374230074_070536.html

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Economía OPINIÓN Resucitar el cortafuegos de la Gran Depresión Las propuestas para recuperar la ley Glass-Steagall chocan con la banca SANDRO POZZI Nueva York 21 JUL 2013 - 00:00 CET

Elisabeth Warren y John McCain, proponentes de la reforma. / ANDREW HARRER (BLOOMBERG) Los grandes bancos animaron el arranque de la temporada de resultados en Wall Street. Goldman Sachs dobló el beneficio en el último año, como Morgan Stanley, mientras que JP Morgan elevó los suyos un 31%; Citigroup, un 42%, y Bank of America, un 63%. Todos gracias al negocio de la banca de inversión y a operaciones con acciones y deuda. Pese a superar las expectativas, hay mar de fondo en la banca estadounidense. Esos números corresponden al pasado. Los inversores prefieren mirar al futuro y los toman con cautela, en previsión del impacto que puede tener la nueva regulación financiera.

Hace dos semanas, la Reserva Federal aprobaba los nuevos requerimientos de capital. Y a los pocos días, en la víspera de la publicación de los resultados, emergía la primera propuesta legislativa seria para resucitar la ley Glass-Steagall, un texto que estuvo en vigor entre 1933 y 1999 que separaba las actividades de banca comercial de las de inversión. Esa vuelta legislativa está patrocinada por la senadora demócrata Elizabeth Warren, y el republicano John McCain. “La banca tradicional debe ser aburrida”, dijo Warren en la presentación, “el que quiera arriesgar, que lo haga en Wall Street”. La senadora recordó que uno de los objetivos de la última reforma financiera era evitar que los grandes bancos crecieran más, porque esa concentración creaba riesgos. Hoy en día, indicó, las cuatro mayores firmas son un 30% más grandes. La propuesta bipartidista pone en evidencia el encendido debate en EE UU sobre si los reguladores están haciendo lo suficiente para vigilar a los bancos que se consideran demasiado grandes para quebrar. Es como si vinieran a decir que la ley Dodd-Frank, que entró en vigor hace tres años, y Basilea III no fueran suficientes para lograr que los bancos sean más honestos.

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El objetivo es separar la actividad de la banca comercial y la de inversión La Glass-Steagall original se estableció durante la Gran Depresión. Se hizo para evitar que los bancos usaran el dinero de los depósitos para hacer operaciones de riesgo. En 1980 empezaron a introducirse modificaciones en la legislación que la convirtieron en un coladero. La norma fue suspendida en 1999, con el demócrata Bill Clinton en la Casa Blanca. La intención es recuperar algunos elementos de aquella legislación. Al levantar esta especie de muro, explican los senadores, se quiere evitar que las firmas de Wall Street que asumen riesgos excesivos puedan acudir a la Reserva Federal cuando tienen problemas. Eso creará un sistema financiero más seguro, afirman, y protegerá, de paso, al contribuyente y a la economía. Como señala Warren, la Glass-Steagall del siglo XXI espera ayudar así a reducir el tamaño de los megabancos. El problema, como señalan desde el sector financiero, “es que la historia nunca se repite” igual. Es como decir que la próxima crisis será diferente a la de 2008 y que la nueva regulación debe, por tanto, concentrarse en los problemas actuales. Las voces para volver a la era de la Glass-Steagall emergieron hace cinco años, tras estallar la crisis. La ley Dodd-Frank se quedó corta en ese aspecto, y el debate volvió a cobrar fuerza hace un año, coincidiendo con las pérdidas multimillonarias de JP Morgan en un paquete de deuda europea, y con Sandy Weill, el creador de Citigroup, diciendo que era la hora de partir los bancos. Ahora, la iniciativa empieza a tomar forma, pero lo hace tocada, lo que presagia un camino difícil para salir adelante en el Congreso, donde además se vive una profunda división interna. Otros intentos por resucitar la Glass-Steagall se quedaron en eso, en intentos, porque no lograron aglutinar el apoyo suficiente para hacer frente al lobby de Wall Street. Daniel Tarullo, gobernador de la Reserva Federal, acaba de echar un jarro de agua fría a la acalorada discusión entre Wall Street y Washington, al mostrar sus dudas sobre la vuelta a la antigua ley. El problema, insiste el hombre encargado en la Fed de llevar a delante las cuestiones reglamentarias, es otro. La norma estuvo en vigor entre 1933 y 1999, cuando la derogó Bill Clinton Tarullo asevera que la ley no habría evitado la última crisis. El mismo argumento de Jamie Dimon desde JP Morgan, la voz más crítica contra el exceso de regulación. La cuestión está en el grado de separación que se quiere lograr, señala el funcionario, al tiempo que recuerda que Bear Stearns y Lehman Brothers no eran bancos comerciales cuando quebraron. Otros analistas temen que el negocio se vaya hacia firmas más pequeñas menos diversificadas. Timothy Sloan, director financiero de Wells Fargo, apela a esa diversificación para decir que su banco es seguro y que no necesita ser dividido. Warren, la máxima impulsora de la nueva agencia de protección al consumidor en cuestiones financieras, admite que su propuesta “no resuelve todos los problemas” que plantea el “demasiado grande para quebrar”. Pero, como McCain, cree que es un buen primer paso para evitar que las estrategias de riesgo que asumen los grandes bancos no afecten a los depósitos de sus clientes y ni al conjunto de la economía. El debate aún está lejos de concluir. http://economia.elpais.com/economia/2013/07/19/actualidad/1374230958_123736.html

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vox Research-based policy analysis and commentary from leading economists When is the time for austerity? Alan Taylor, 20 July 2013 Recent austerity policies have been guided by ideology rather than research. This column discusses research that reconciles disparate estimates of fiscal multipliers in the literature. It finds that common identification assumptions are problematic. Matching methods based on propensity scores show how contractionary austerity really is, especially in economies operating below potential. In 1809, on a battlefield in Portugal, the first recognisable medical trial evaluated bloodletting on a sample of 366 soldiers allocated into treatment and control groups. The cure was shown to be bogus. It was the beginning of the end of pre-modern medicine. Yet problems of allocation bias— i.e., 'insufficient randomisation' – pervaded poor experimental designs until the landmark British Medical Research Council trials of patulin and streptomycin in the 1940s. Since then the randomised controlled trial has been the foundation of evidence-based medicine. Is a similar evidence-based macroeconomics possible? One pressing and highly topical context is the effects of austerity on output (see Alesina and Ardagna 2010, Guajardo et al. 2011). This might seem like a natural and helpful line of debate. Natural, since experimental techniques drawn from medicine have been fruitfully incorporated in other fields of economics. Helpful, for some, since more clarity on fiscal impacts might be welcome, given the uproar over European and UK austerity programs. Ironically, the policy debate is sprinkled with medical metaphors. In 2011 German Finance Minister Wolfgang Schäuble wrote that “austerity is the only cure for the Eurozone”; while Paul Krugman likened it to "economic bloodletting”. In the Financial Times, Martin Wolf, cautioned that “the idea that treatment is right irrespective of what happens to the patient falls into the realm of witch-doctoring, not science” while Martin Taylor, former head of Barclays, put it quite bluntly: “Countries are being enrolled, like it or not, in the economic equivalent of clinical trials.”1 In a new paper we exploit a treatment-control design using statistical techniques designed for situations, experimental or otherwise, where underlying allocation bias may prevail (Jordà and Taylor 2013). This turns out to be a serious problem here, as in many other macroeconomic contexts where endogenous policy actions epitomise the “insufficient randomisation” problem. Confronting the great austerity debate For consistency we use the very same OECD annual panel dataset (17 economies; 1978–2009) common to two high-profile yet contradictory studies. The influential “expansionary austerity” idea came to be associated with Alesina and Ardagna (2010); but an IMF study reached the opposite conclusion of “contractionary austerity” (Guajardo et al. 2011). For minimal parameterisation, we use local projection methods (Jordà 2005) to estimate output impacts of fiscal policy up to four years out. These flexible methods permit us to compare different identification strategies and easily allow for possibly non-linear, or

332 state-dependent responses. Indeed we find that responses are very different in booms and slumps, as emphasised by Keynes in the 1930s. Step 1: Replicating expansionary austerity The simplest identification of the causal effect of a fiscal policy intervention relies on a weak form of the selection-on-observables assumption. Conditional on a set of controls, variation in policy interventions is supposedly largely random. However, if policy interventions conditional on controls are systematically determined by an unobserved variable that is correlated with the outcome then the method fails. As a first step we estimate linear-projection impacts of fiscal policy using the Alesina- Ardagna measure of policy, the change in the cyclically-adjusted primary balance from year 0 to year 1.2 These first estimates suggest, consistent with Alesina-Ardagna, that austerity is expansionary. The significant coefficients here have a positive sign. In Table 1 we stratify the results by the state of the cycle (2 bins, boom and slump, based on the sign of HP-filtered log output, yC) at time 0; we see that the result is entirely driven by what happens in booms. It is only in booms that we find a significant response of real GDP to fiscal tightening, with a coefficient or multiplier of about +0.2* in years 1 and 2 (+ p < 0.10, * p < 0.05). The effects seem to taper off in years 3 and 4. But in slumps, the policy response is not statistically significant and is typically negative. Table 1. Estimates of the impact of 1% of GDP fiscal consolidation, by state of the economy

Step 2: Replicating contractionary austerity Alternative identification is possible if valid instrumental variables are available. This method assumes that if there is correlation between the instrument and the control, then one has a source of exogenous variation in policy interventions with which to calculate the causal effect (e.g., Auerbach and Gorodnichecko 2013, Owyang et al. 2013). As a next step we therefore replace our linear-projection estimator with an instrumental- variable linear-projection estimator. The change in cyclically-adjusted primary balance is instrumented by the IMF set of potential 'narrative' instruments, i.e. indicators of dates of fiscal consolidations that, through a reading of the historical record, might be reasonably considered to be exogenous.3 Here the findings are very much consistent with the IMF results in Table 2. Austerity appears contractionary. The significant coefficients here have a negative sign. However, stratification shows that this result is now largely driven by what happens in slumps. The effects in a boom are imprecisely estimated but negative. In a slump we find significant negative responses of real GDP to fiscal tightening from year 1 all the

333 way out to year 4. Over 4 years the sum of these effects is −2.68*, so the average loss for a 1% of GDP fiscal consolidation is a depressed output level of about to 0.7% per year over this horizon. Table 2. Instrumental-variable estimates of the impact of 1% of GDP of fiscal consolidation, by state of the economy

Endogenous austerity: The fiscal treatment is not randomly allocated Naturally, a key question is whether these instruments are really exogenous. In fact, they aren’t. The IMF’s fiscal consolidation episodes can be predicted using predetermined macroeconomic controls. They may not be valid instruments. Thus, even with this instrument, which might alleviate the most glaring issues of endogeneity and measurement bias, some endogeneity remains in the treatment variable. We find evidence here from multiple criteria, including exogeneity tests and balance checks. Table 3 presents probit models of the IMF treatment variable (a consolidation from year 0 to year 1). In column 1 the austerity treatment is more likely when public debt is higher. Governments pursue austerity when debt is elevated. In column 2, when output is further below potential or growing more slowly, there is an increase in the likelihood of treatment. Finally, columns 3 and 4 add the lag of treatment. Being in treatment today is a good predictor of being in treatment tomorrow. Austerity programs persist. Table 3. Austerity treatment episodes are a non-random allocation

Step 3: Estimates of the average effect of fiscal consolidations

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We offer a new take in a third and final step. If the IMF’s austerity treatment variable has a significant forecastable component this could induce allocation bias in estimated responses. To address this we use local projections again, but with an inverse probability weight regression-adjustment method to calculate average treatment effects.4 The inverse probability weight regression-adjustment estimator uses a saturated first- stage probit model to predict treatment probability based on observables, getting as close as possible to a quasi-randomised experiment. This first stage prediction is called the policy propensity score. The second stage outcome regression then corrects for the allocation bias in situations where the outcome also depends on observables, but is in every other respect exactly the same specification used in the linear-projection specifications. The consistency of this estimator is 'doubly robust' (unlike inverse probability weight or regression adjustment alone) and guards against incorrect model specification in either the treatment regression or the outcome regression. Using the two-stage estimator, Table 4 shows that austerity has a mostly negative effect, all years, in both bins. It has larger and more statistically significant negative effects in the slump. In booms, which one could view as the 'full employment' case, we find smaller (and mostly statistically insignificant) impacts of fiscal consolidation on output. Summed over four years, the estimates of the average treatment effects are -1.13+ in booms but -2.48* in slumps. Table 4. Doubly robust estimates of the impact of fiscal 'treatment', by state of the economy

Three views of austerity: The good, the bad and the ugly Our results contrast with the expansionary austerity view of Alesina and Ardagna, and even amplify the opposing view of the IMF. For comparisons we have to adjust for the scale of the treatments by the average treatment size, the mean of the IMF measured consolidation (in % of GDP). There is little variation in treatment size across the bins, so the average treatment effects are in fact comparable to multipliers because the average treatment, coincidentally and conveniently, is close to one. In recent times austerity has been systematically applied in weak economic conditions: plus ça change. But in a bad current state the economy is more likely to grow faster than trend going forward. By failing to allow for the endogeneity of treatment we could end up with a far too rosy view of the aftermath of fiscal consolidations. A dead cat bounces, regardless of whether it jumped or was pushed. Using ordinary-least-squares estimation we would walk away believing in expansionary austerity, or no effect when the economy is weak. Using 'narrative' instrument variables we might believe in contractionary austerity except when the economy is strong, but the

335 estimates are possibly biased as the instruments may not be valid as allocation into treatment is not random. Using our two-stage method to deal with allocation bias, we find stronger evidence of contractionary austerity in the weak economy with much more precise estimates. These results suggest that only a strong economy can bear a fiscal consolidation without significant output losses. Counterfactual: Coalition austerity and the UK recession To provide illustration, we apply our estimates to make an (out-of-sample) counterfactual forecast of the post-2007 path of the UK economy without the fiscal austerity policies imposed by the coalition government after the 2010 election. Two assumptions may be needed to make this exercise relevant. First, we assume that the UK had fiscal space and was not forced to do austerity; this may be defended in that real GDP is now worse than was expected in 2010, and debt to GDP higher than expected, yet gilt yields remain ultra-low in real terms (and at their lowest nominal level in their 280 years of recorded history). Second, we assume that policymakers care about timing fiscal adjustments so as to mitigate damage to the real GDP path of the economy; this is, at least, an oft-stated goal of most policymakers. The results are presented in Figure 1, where we show actual and forecast paths for UK real GDP from 2007 (the business cycle peak) through 2013. How much of the poorer outturn can be attributed to the fiscal policy choice of instigating austerity during a bad slump? The answer, using our model as described above, is about 60%. Without austerity, UK real output would now be steadily climbing above its 2007 peak, rather than being stuck 2% below. Figure 1. UK actual path and counterfactual path without austerity

The residual relative to the forecast could be accounted for by various omitted factors, as has been noted (Davies 2012), such as export patterns in the Eurozone and idiosyncratic UK sector shocks. There could also have been over-optimism in the 2010 forecast. However, a major caveat suggests that we likely have a biased underestimate of the effects of current UK austerity. This caveat is the zero lower bound, when fiscal multipliers are known to be much larger in both theory and evidence. Our UK out-of-

336 sample counterfactual does correspond to a 'liquidity trap' environment, but our in- sample data overwhelmingly do not.5 Thus our estimate of austerity’s effects in the UK is probably conservative. Summary Few economic policy issues generate as much controversy as the ongoing austerity argument, and, as Europe and the UK endure double-dip stagnation, the debate is probably far from over. Fiscal consolidations are not exogenous events, even those identified by the narrative approach. By reweighting observational data to approximate an experiment where treatment is 'as if' at random (based on a first-stage model), we estimate policy responses in a way that corrects for allocation bias. Our estimates are closer to those from the instrumental-variable specification than from the ordinary-least-squares specification. We confirm adverse impacts as in the IMF study. But we also find that this is a 'bad times' result. Fiscal contraction prolongs the pain when the state of the economy is weak, much less so when the economy is strong. Keynes is still right, after all: “The boom, not the slump, is the right time for austerity at the Treasury.” References Alesina, A, and R Perotti (1995), "Fiscal Expansions and Adjustments in OECD Economies", Economic Policy 10 (21): 207–247. Alesina, A, and S Ardagna. (2010), "Large Changes in Fiscal Policy: Taxes versus Spending" In Tax Policy and the Economy, edited by J R Brown, vol. 24. Chicago: University of Chicago Press, pp. 35–68. Almunia M, A Bénétrix, B Eichengreen, K H O’Rourke, and G Rua (2010), "From Great Depression to Great Credit Crisis: Similarities, Differences and Lessons", Economic Policy 25 (62): 219–265. Angrist, J D, Ò Jordà and G M Kuersteiner (2013), "Semiparametric Estimates of Monetary Policy Effects Before and Since the Great Recession: String Theory Revisited", Paper presented at the NBER Summer Institute. Auerbach, A J and Y Gorodnichenko (2013), "Fiscal Multipliers in Recession and Expansion", In Fiscal Policy after the Financial Crisis edited by AAlesina and F Giavazzi. Chicago: University of Chicago Press. Christiano L, M Eichenbaum and S Rebelo (2011), "When Is the Government Spending Multiplier Large?" Journal of Political Economy 119 (1): 78–121. Davies, G (2012), "Why is the UK Recovery Weaker than the US?" Financial Times, November 14. Eggertsson, G B, and P Krugman. (2012), "Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo Approach", Quarterly Journal of Economics 127 (3): 1469–1513. Guajardo J, D Leigh, and A Pescatori (2011), "Expansionary Austerity: New International Evidence", IMF Working Paper 11/158. Hirano K, G W Imbens, and G Ridder (2003), "Efficient Estimation of Average Treatment Effects Using the Estimated Propensity Score", Econometrica 71(4): 1161– 1189.

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Imbens, G W (2004), "Nonparametric Estimation of Average Treatment Effects Under Exogeneity: A Review", Review of Economics and Statistics 86(1): 4–29. Jordà, Ò and A M Taylor (2013), "The Time for Austerity: Estimating the Average Treatment Effect of Fiscal Policy", Paper presented at the NBER Summer Institute. Lunceford, J K and M Davidian (2004), "Stratification and weighting via the propensity score in estimation of causal treatment effects: A comparative study", Statistics in Medicine 23: 2937–60. Owyang M T, V A Ramey and S Zubairy (2013), "Are Government Spending Multipliers Greater During Periods of Slack? Evidence from 20th Century Historical Data", NBER Working Paper 18769. Rendahl, P (2012), "Fiscal Policy in an Unemployment Crisis", Cambridge Working Papers in Economics 1211. Robins, J M, A Rotnitzky and L P Zhao (1994), "Estimation of Regression Coefficients When Some Regressors are not Always Observed", Journal of the American Statistical Association 89(427): 846–66. Romer, C D, and D H Romer (1989), Does monetary policy matter? A New Test in the Spirit of Friedman and Schwartz. In NBER Macroeconomics Annual 1989 edited by Oliver J. Blanchard and Stanley Fischer. Cambridge, Mass.: MIT Press, pp. 121–170.

1 The quotes are from ft.com, nytimes.com, ft.com and ft.com, respectively. 2 We can consider all such shocks, or restrict attention to “large” shocks (larger in magnitude than 1.5% of GDP), a cutoff value used by Alesina and Ardagna and proposed earlier by Alesina and Perotti (1995), but the results are robust to these changes. 3 This is “narrative-based identification” (e.g. Romer and Romer 1989). 4 On the inverse-probability-weight estimator in economics see Hirano etal. (2003); for an application to macroeconomics with policy propensity scores, see Angrist et al. (2013). On the inverse probability weight regression-adjustment estimator and the “doubly robust” property see Robins et al. (1994) and Lunceford and Davidian (2004). A survey of these and related estimators is found in Imbens (2004). 5 Our estimates are based on a sample from 1978 to 2007, when the zero lower bound was virtually absent from any country-year observations in the dataset (the only exceptions being 7 country-year observations, out of a total of 173 consolidation episodes, all of these relating to Japan in the 1990–2007 period). As is well known in theory (Christiano et al. 2011; Eggertsson and Krugman 2012; Rendahl 2012) and also from historical evidence from the Great Depression (Almunia et al. 2010), fiscal multipliers are much larger in zero-lower-bound conditions than in normal times when monetary policy is away from this constraint. But in the post-2008 forecast period for the UK the zero lower bound was a binding constraint, which would tend to make even our already large estimated fiscal impacts an underestimate of the true impacts. Alan Taylor When is the time for austerity? 20 July 2013 http://www.voxeu.org/article/when-time-austerity

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vox Research-based policy analysis and commentary from leading economists EZ banking union with a sovereign virus Daniel Gros, 14 June 2013 The doom-loop between banks and the national governments played a dominant role in the Eurozone crisis for Ireland and Cyprus. A Eurozone banking union is usually viewed as the solution. This column argues that the doom-loop cannot be undone as long as banks hold oversized amounts of their government’s debt. A simple solution would be to apply the general rule that banks are prohibited from holding more than a quarter of their capital in government bonds of any single sovereign. Related / A banking union for the EurozoneGiovanni Dell'Ariccia, Rishi Goyal, Petya Koeva-Brooks, Thierry Tressel/ Banking union for Europe - risks and challengesThorsten Beck/ Is Europe ready for banking union?Nicolas Véron The purpose of the proposed banking union is to de-link banks from their sovereigns. • Putting the ECB in charge of supervision and creating a common resolution mechanism should help. But this is not enough. • European banks hold too much government debt of their own governments to really sever the sovereign-bank link. Until the link is broken, the Eurozone will continue to be vulnerable to disruptive, self- reinforcing feedbacks of the type that brought the Eurozone to the brink of collapse in 2011-12. Figure 1. (National) government debt held by domestic banks in France, Germany, Italy and the US (% of total)

Source: Agence France Trésor, Bundesbank, Bank of Italy and FED.

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Data on share of own-government debt in bank holdings The concentration of public debt on bank balance sheets is not just a result of the euro crisis (Figure 1). The numbers show that French and Italian banks always held a considerable fraction of total public debt. The data for Germany are surprising. They show that in the not-so-distant past more than one half of the country’s total national debt was held by German banks. The German banking system has diversified its holdings of government debt only since the creation of the euro. Why do banks hold so much government debt? The answer is simple – regulators have made it attractive for them to hold such debt. • Banks do not have to hold any capital against their holdings of government debt. Banks hold capital against their investments only if regulators assign a risk weight to this investment. But the risk weight is zero on sovereign debt. This assumption that government debt is riskless permeates all banking regulation and thus contributes indirectly in many ways to induce banks to hold government debt. It is difficult to understand why this assumption has not been changed after the ‘PSI’ (private-sector involvement) operation in Greece showed that banks can lose money on their holdings of Eurozone sovereign bonds. Moreover, PSI is now also official policy since the ESM Treaty foresees explicitly the possibility of a haircut on public debt if a debt sustainability analysis shows that the country cannot service its debt in full. There is thus no reason to continue with the regulatory fiction that sovereign debt is always riskless.1 Introducing risk weights for government debt will not be enough to prevent a crisis because of the ‘lumpiness’ of sovereign risk. Experience has shown that sovereign defaults are rare events, but the losses are typically very large (above 50%) when default does materialise. In many peripheral countries, banks hold sovereign debt equal to (or greater than) their total capital. Even with a risk weight of 100%, these banks would only have sufficient capital reserves to cover losses of 8%. • Large banks are allowed to cherry-pick regulatory approaches. There is an obscure but very important clause: ‘Permanent Partial Exemption’. This term refers to one of the many wrinkles in the way the EU has implemented the Basel agreements on banking regulation in its own capital requirements Directive (CRD). In essence large banks are allowed to use their own models to assess the riskiness of their own assets. But when these models would signal that government debt has become risky (for example because the debt has become unsustainable or CDS spreads signal risk), the normal risk models are put aside in favour of the general presumption that government debt can never be risky. In essence banks can cherry pick. Most large banks use their internal risk models to calculate the riskiness of their lending to households, the corporate sector and their other assets. By doing so they can generally arrive at a lower level of capital requirement than under the so-called standardised approach in which all lending falls in certain risk classes determined by ratings levels. However, these internal risk models are put aside in the case of government debt. Given this, there is little wonder that European banks lack the capital to weather a sovereign debt crisis (which by regulatory definition should not be possible). • Liquidity requirements favour government bonds.

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Another reason why banks hold large amounts of government debt on their balance sheets is that they have to hold a certain amount of ‘liquid’ and safe assets. Until recently, only government bonds were recognised as liquid. However, experience over the last few years has shown that at times even government bonds can become illiquid. Forcing banks to hold large amounts of government bonds might make sense if it were true that that this is the only class of liquid and safe assets, but this is manifestly no longer true. Fortunately the latest version of the so-called liquidity cover ratio (LCR) allows banks to also hold other assets to satisfy the requirement of the LCR, whose purpose is to ensure that a bank can always offset potential outflows of funds by selling liquid assets. This incentive to hold government debt might thus be somewhat diminished. • There is no limit on the concentration of sovereign risk. The most basic principle of finance is reducing risk through diversification. The need to diversify risk is the reason why all regulated investors (banks, insurance companies, investment funds, pension funds) have to limit their exposure to any single counterparty to a fraction of their total investment or capital (for banks). For banks, the limit on the exposure to any one borrower is 25% of their capital, but this limit does not apply to sovereign debt. The logic of this exemption was simple: since there was thought to be no risk in sovereign debt, there was no reason to put any limits on its concentration. The result of this lack of exposure limits has been that banks in the periphery have too much debt of their own government on their balance sheets which has greatly contributed to the deadly feedback loop between sovereigns and banks. Table 1 below shows the degree of ‘domestic leverage’ of the systemically important banks in major Eurozone countries that were subject to the EBA stress tests (and soon will be supervised by the ECB). It is apparent that in most countries the domestic banking system would not survive a Greek-style ‘haircut’ on public debt. (In the context of the PSI operation of March 2012, holders of Greek bonds had to accept a nominal haircut of over 50%, and on a mark-to-market basis the haircut was over 80%. It is apparent that no bank that has a sovereign exposure worth over 100% of its capital would survive such a loss.) Table 1. Domestic sovereign debt leverage (sovereign exposure/capital) 2010 2011 2012 Q4 Q4 Q2 DE 264% 241% 235% ES 172% 131% 137% FR 73% 53% 61% IT 205% 155% 176% PL 156% 141% 115% PT 117% 102% 100% UK 50% 52% 50% Source: CEPS database. All four elements could and should be changed. Concluding remarks The belief that government debt is riskless is a fundamental assumption in banking regulation. In Europe this has induced banks to hold large amounts of government debt 341 and, even worse, to concentrate their holdings on their own sovereign – thus ensuring that a sovereign-debt crisis also becomes a banking crisis. The key aspect for the stability of the euro and its banking system is the concentration of bank holdings of their own sovereign. If this could be changed, the banking system would become much more resistant to sovereign-debt problems. • A simple solution would be to apply the general rule that banks are prohibited from holding more than 25% of their capital in government bonds of any single sovereign. This rule could be applied only to new investment during a transition period so that it would not force any abrupt selling of the existing holdings. The treatment of government debt in banking regulation is one of those dogs that did not bark. The EU has recently completed a wide-ranging overhaul of its banking regulation framework in the context of the renewal of the capital requirements Directive (CRDIV). The regulatory treatment of sovereign debt was not even discussed in this context. Why? Simply because governments want to maintain a source of demand for their own bonds. But this self-serving treatment of government debt in banking regulation is short-sighted because it leads to a situation in which Eurozone banks hold a large proportion of government debt – much more than in the US. This is dangerous given that banks are highly leveraged and that sovereign debt is inherently subject to default risk within the Eurozone. For financial-stability reasons, it would thus be preferable if a higher proportion of government debt were held by unleveraged investors, e.g. directly by households or via investment funds. But this would of course reduce the income of the banks. The unholy alliance of short-sighted finance ministers and bankers interested in keeping their business will be very costly because it perpetuates the negative feedback loops between banks and sovereigns. References Acharya, Viral V and Sascha Steffen (2012), “The ‘Greatest’ Carry Trade Ever? Understanding Eurozone Bank Risks”, University of Virginia, Charlottesville, VA; 18 November. BIS (2013), “Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools” Bank for International Settlements, January, Basel. De Grauwe, Paul (2011), “Governance of a Fragile Eurozone”, CEPS Working Document No. 346, CEPS, Brussels, May. Kopf, Christian (2011), “Restoring financial stability in the Eurozone”, CEPS Policy Brief, CEPS, Brussels, March. Gros, Daniel (2013), “Banking Union with a Sovereign Virus The self-serving regulatory treatment of sovereign debt in the Eurozone”, CEPS Policy Brief No. 289, CEPS, Brussels, 27 March.

1 The standard objection to risk weights on sovereign debt is that they contradict fundamental principles on which the Basel capital adequacy regime is based. It is indeed true that all Basel accords stipulated that banks do not necessarily have to hold any capital against claims on their own government (and in their own currency) because government debt is regarded as riskless if it is the national currency. 342

The rationale for zero risk weights under normal conditions (i.e. the country has its own national currency) is clear: when the country has its own currency the government can, in extremis, always order the central bank to print enough money to be able to service its debts. But as emphasised by (Kopf 2011 and de Grauwe 2011), in the Eurozone no individual debtor government has any authority over the creation of money. The ECB is actually forbidden to provide monetary financing to any government, or even the EU authorities. When monetary and fiscal authorities are separate entities as in the Eurozone, default risk on sovereign debt is not zero. This was the intellectual mistake made when the Basel rules were transcribed into EU law (i.e. the capital requirements Directive). http://www.voxeu.org/article/ez-banking-union-sovereign-virus vox Research-based policy analysis and commentary from leading economists Fiscal implications of the ECB’s bond- buying programme Paul De Grauwe, Yuemei Ji, 14 June 2013 The monetary-fiscal policy connection is under scrutiny by the German Constitutional Court in the context of the ECB’s OMT bond-buying programme. This column argues that most analyses are deeply flawed by the misapplication of private-company default principles to the central bank. ECB bond-buying transforms public bonds into monetary base, and sovereign-default risk into inflation risk. The real question is: What is the non-inflationary limit to money-base expansion? This depends upon the economic situation and is much higher in the current liquidity-trap setting. There is a lot of confusion about the fiscal implications of the government bond-buying programme – the OMT, or Outright Monetary Transactions – that the ECB announced last year. • This confusion arises mainly because the principles that guide the solvency of private companies (including banks) are applied to central banks. • The level of confusion is so high that the president of the Bundesbank turned to the German Constitutional Court arguing that the OMT programme of the ECB would make German citizens liable for paying taxes to cover potential losses made by the ECB. In this column we argue that the fears that German taxpayers may have to cover losses made by the ECB are misplaced. They are based on a misunderstanding of solvency issues that central banks face. Indeed, German taxpayers are the main beneficiaries of such a bond-buying programme. Solvency central banks versus private agents: The key difference Private companies are said to be solvent when their equity is positive, i.e. when the value of their assets exceeds the value of their outstanding debt. The solvency of a private company can also be formulated in terms of the maximum amount of losses that a company can bear at any given time. Thus, a private company is said to be solvent

343 when its losses do not exceed the value of its equity. Since in efficient markets the latter is equal to the present value of future profits, we arrive at the solvency constraint that says that the losses today cannot exceed the present value of expected future profits. The problem arises when these solvency constraints are applied to central banks. • This misapplication of private principles has led some to conclude that the loss the ECB (or any central bank) can bear should not exceed the present value of future expected seigniorage gains (see Corsetti and Delada 2013). • Similarly, it is sometimes concluded that a central bank needs positive equity to remain solvent (Stella, 1997, Bindseil et al. 2004). These solvency constraints should not be applied to the central bank; central banks cannot default. A central bank can issue any amount of money that will allow it to 'repay its creditors', i.e. the money holders.1 Such a 'repayment' would just amount in converting old money into new money. Contrary to private companies, the liabilities of the central bank do not constitute a claim on the assets of the central bank. The latter was the case during gold standard when the central bank promised to convert its liabilities into gold at a fixed price. Similarly in a fixed exchange-rate system, the central banks promise to convert their liabilities into foreign exchange at a fixed price. The ECB and other modern central banks that are on a floating exchange-rate system make no such promise. As a result, the value of the central bank’s assets has no bearing for its solvency. The only promise made by the central bank in a floating exchange-rate regime is that the money will be convertible into a basket of goods and services at a (more or less) fixed price. In other words the central bank makes a promise of price stability. That’s all. Seigniorage is not a limit Thus it makes no sense to state that the limit to the losses a central bank can make at any point in time is given by the present value of future profits (seigniorage). There is no such limit. The central bank can make any loss provided the loss does not endanger its promise to maintain price stability. Also it is not correct to claim that the central bank needs to hold positive equity 'to remain solvent'. A central bank needs no equity. As a result the claim that is sometimes made that a central bank with negative equity needs to be recapitalised by the treasury is senseless. To be clear: • The central bank (that cannot default) needs no fiscal backing from the government (who can default). • The only backing the central bank needs from the government is that it can keep its monopoly power to issue money in the territory over which the sovereign has jurisdiction. With that power granted by the sovereign the central bank is freed from any solvency constraint. Let us now apply these first principles to the issue of how a bond-buying programme can have fiscal implications. We first discuss the situation of the central bank that faces

344 only one sovereign. Then we discuss the problem of the central bank in a monetary union facing many sovereigns. The central bank of a stand-alone country We will consider the case of a central bank that buys government bonds in the secondary market.2 By buying government bonds the central bank transforms the nature of the public-sector debt. When the central bank buys its government’s debt, the debt is transformed: • Government debt that carries an interest rate and a default risk becomes debt that is a monetary liability of the central bank (money base) that is default-free but subject to inflation-risk. To understand the fiscal implications of this transformation, it is important to consolidate the central bank and the government (after all they are separate branches of the public sector). After the transformation the government debt held by the central bank cancels out. It is an asset of one branch (the central bank) and a liability of another branch (the government). As a result, it disappears. The central bank may still keep it on its books, but it has no economic value anymore. In fact the central bank may do away with this fiction and eliminate it from its balance sheet and the government could then eliminate it from its debt figures. It has become worthless because it was replaced by a new type of debt, namely money, which carries an inflation risk instead of a default risk. This is why It makes no sense to say central banks lose when the market price of the government bonds drops. If there were a loss for the central bank it would be matched by an equal gain of the government (whose market value of the debt has dropped in the same proportion). There is no loss for the public sector. Public debt held by the public sector is different We arrive at an important conclusion: • When the central bank has acquired government bonds, a decline in the market value of these bonds has no fiscal implications. The loss in one branch of the public sector (the central bank) is offset by an equal gain in another part of the public sector (the government), leaving nothing to be paid by the taxpayer. Another way to see this is to look at the interest-rate flows underlying bond holdings. Let’s take an example and suppose the central bank has bought €1 billion of government bonds. These have a coupon of, say, 4%. Thus the central bank that keeps these bonds on its balance sheet receives €40 million from the government every year. The bookkeeping practice is to count this as profits of the central bank. At the end of the year the same central bank will have to hand over its profits to the government. Assuming that the marginal cost of managing this bond portfolio is zero, the central bank will hand over €40 million to the government. This is the left hand paying the right hand, so to speak. This bookkeeping practice has led to the perception that the interest revenue is to be considered as seignorage. It is not. There is no profit for the public sector. The profit of the central bank is exactly offset by a loss of the government. Both could do away with this bookkeeping convention because there is no economic substance to these losses and profits. 345

• It is literally true that the central bank could put the government bonds 'into the shredding machine'; nothing would be lost. In our example, the central bank would stop receiving €40 million a year, and would stop paying out €40 million to the government every year. What happens if the government defaults on its outstanding bonds? • Default leads to losses for private holders of these bonds. • But it is immaterial for central bank-held bonds. These are now valued at zero, but they were also already worthless before the default. This is the right hand taking it back from the left hand. Think about it in terms of the interest flows. After the default, the central bank stops receiving interest payments from the government, but by the same token it stops paying these back to the government. Nothing has happened in the public sector. Thus the loss that the central bank is making as a result of the default has no fiscal implications. Price stability and public-sector default There is an issue when it comes to price stability and its link to a government default. If the central bank keeps its liabilities (money base) under control, the default by itself will not lead to more inflation. The latter will arise only if the government were to force the central bank to issue more of these monetary liabilities, e.g. to finance current budget deficits that after the default the government cannot finance by issuing bonds anymore. It is sometimes argued that if the central bank has no assets (because of a default by the government), then it no longer has instruments to reduce the money stock. This may sometimes be necessary to reduce inflationary pressures. This argument does not hold water. There are two ways a central bank that lacks assets can reduce the money stock. • First, the central bank can issue interest-bearing bonds and sell them in the market. This has the effect of reducing liquidity (money base). • Second, the central bank can raise minimum reserve requirements. As a result, the existing stock of liquidity is 'deactivated', which has the same effect of a decline in the money base. The central bank of a monetary union Things are more complicated in a monetary union that is not also a fiscal union. Here the fiscal implication of central-bank bond buying is more complicated. The crux is the presences of ‘n’ sovereigns. In the Eurozone, n = 17 (soon to be 18 with Latvia). • If we could consolidate the ECB and the 17 sovereigns into one public sector, the analysis would carry through unchanged. • But we cannot; the Eurozone is not a fiscal union. As a result a bond-buying programme will lead to transfers among participating member countries. To clarify thinking about this problem, assume that the ECB buys €1 billion of Spanish bonds with a 4% coupon. The fiscal implications are now as follows. • The ECB receives €40 million interest annually from the Spanish Treasury. • The ECB returns this €40 million every year to the EZ national central banks.

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The distribution is pro rata with national equity shares in the ECB (see ECB 2012). • The national central banks transfer this to their national treasuries. For example, the ECB will transfer back 11.9% of the €40 million to the Banco de España. The rest goes to the other member central banks. The largest receiver is the German Bundesbank; with its equity share of 27.1%, it would get €10.8 million. Thus in a monetary union (and in the absence of a fiscal union) a bond-buying programme leads to fiscal transfers among countries – but not the one common in the public perception, especially in Germany. • An ECB bond-buying programme leads to a yearly transfer from the country whose bonds are bought to the countries whose bond are not bought. It should be noted that the ECB could implement a bond-buying programme that avoids fiscal transfers by buying national government bonds in the same proportions to the equity shares of the participating NCBs. This has in fact been proposed sometimes. But this would not eliminate all transfers because the interest rates on the outstanding government bonds are not the same. In fact the countries with the highest interest rates would in this weighted bond-buying programme be net payers of interest to the countries with the lowest interest rates. Thus even a bond-buying programme weighted by the equity shares would involve fiscal transfers from the weaker (debtor) countries to the stronger (creditor) countries. What happens under a public-sector default? One often hears in the creditor countries that these would be the losers if one of the governments whose bonds are on the balance sheet of the ECB were to default. This is an erroneous conclusion. Returning to our example of an ECB purchase of €1 billion of Spanish government bonds, consider a Spanish defaults on these bonds. • The Spanish government would stop paying €40 million to the ECB. • The ECB would stop transferring this interest revenue back to the member central banks pro rata. • The German taxpayer, for example, would no longer receive the yearly windfall of €10.8 million. In no way can one conclude that German taxpayers, or any EZ taxpayer, would pay the bill of the Spanish default – except in the narrow sense that they would no longer be able to count on the yearly interest revenues. • There is of course the possibility of an inflation tax. We have noted before that at the moment of the bond buying programme interest bearing debt is transformed into monetary liabilities of the ECB (money base). This by itself could lead to inflation, and thus to an inflation tax that would be borne by all holders of euros. This leads to the issue of how large the ECB bond-buying programme can be without generating additional inflation. From explicit taxation to inflation tax Every open-market operation involving the purchase of government bonds creates the potential of inflation because it increases the money base. The key question we have to

347 ask ourselves is how the increase in the money base is transmitted to the money stock. After all, it is the money stock not the money base per se that determines inflation. In Figure 1 we show the evolution of money base and money stock (M3) in the Eurozone since 2004. We find a striking difference between the period before and after the banking crisis of October 2008. • Prior to the Global Crisis, the two monetary aggregates move in unison suggesting that the money multiplier (the ratio of money stock to money base) is constant. A 1% increase in the money stock led to an increase of the money stock of approximately 1%. Things are very different during the crisis period. Figure 1. Money base, money stock (M3) in Eurozone (2007 December=100)

Source: European Central Bank, Statistical Warehouse. Over the period 2008 (Oct) to 2013 (April), the relation between the money base and the money stock breaks down. The money base increased by more than 50%; the money stock increased by only 7%. This suggests that the money multiplier has dropped dramatically. This dramatic decline in the money multiplier has everything to do with the liquidity trap (Krugman 2010). Banks, which accumulate reserves as a result of the liquidity injections by the ECB, hoard these reserves. Their degree of risk aversion is such that they do not use their cash reserves to expand bank credit. As a result, the money stock (M3) does not increase. Figure 2 is also instructive. It shows the average yearly inflation rate and the average yearly growth rates of money base and money stock before and after the banking crisis of 2008. • Prior to 2008 both monetary aggregates increased at practically the same rates; the yearly inflation was 2.3%. • Since 2008 the growth rate of the monetary aggregates diverges dramatically. The money base grows at a yearly rate of 11% while the growth rate of the money stock collapses to less that 2% and inflation drops below 2%. 348

• Our interpretation is that the strong increase in the money base helped to reduce the deflationary forces in the economy, rather than being a source of inflation.3 Figure 2. Inflation, growth MB and M3 (average yearly growth rates)

Source: European Central Bank, Statistical Warehouse. Conclusions The previous analysis suggests the following: • Limits to a bond-buying programme depend on the nature of the economic and financial situation, i.e. the existence of a liquidity trap. • In normal times when an increase of the money base leads to proportional increases in the money stock the limit to a bond-buying programme is tight. If the target for the increase in the money stock is 4.5% (as is the case in the Eurozone where a 4.5% target is assumed to lead to at most 2% inflation) this also means that the money base should not increase by more than 4.5% per year. But then during normal times there is very little need for a bond-buying programme. • The situation has changed dramatically since the start of the banking crisis. During the crisis period the limits to the amount of money base that can be created without triggering inflationary pressures is much higher because of the existence of a liquidity trap. How much higher depends on the money multiplier. In De Grauwe and Ji (2013) we estimate the size of the multiplier during the crisis period and we conclude that it has collapsed to zero. As a result, there is no limit to the size of the bond-buying programme, i.e. the ECB can buy any amount of government bonds without endangering price stability, as long as the crisis lasts. References Bindseil U, A Manzanares and A Weller (2004), "The Role of Central Bank Capital Revisited", Working Paper Series, no. 392, European Central Bank, September. Buiter, W (2008), "Can Central Banks Go Broke?", CEPR Policy Insight 24, 16 May. Corsetti, G and L Dedola (2013), "Is the euro a foreign currency to member states?", VoxEU.org, 5 June.

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De Grauwe, P, and Y Ji (2013), "Fiscal Implications of the ECB’s Bond Buying Program (OMT)", University of Leuven, mimeo. European Central Bank (2012), "Capital subscription", ECB.int, 27 December. Friedman, M and A Schwartz (1961), A Monetary History of the US, Princeton University Press, Princeton. Krugman, P (2010), "Debt Deleveraging and the Liquidity Trap", VoxEU.org, 18 November. Pringle, R (2003), "Why central banks need capital", Central Banking Journal, August. Stella, P (1997), "Do Central Banks Need Capital?", IMF Working Paper, no 83, International Monetary Fund, Washington, DC.

1 We assume here that the central bank does not hold foreign currency liabilities. In that case the central bank can be pushed into defaulting on these foreign currency liabilities because it can only issue domestic currency liabilities (Buiter 2008). 2 Thus we do not discuss direct monetary financing of government budget deficits. 3 See Friedman and Schwartz(1961) for an analyis of the Great Depression in the US. These authors argued that the US Fed at the time failed to increase the money base sufficiently to counter the delflationary forces. As a result, the US money stock actually declined, reinforcing deflation. Paul De Grauwe, Yuemei Ji (2013), Fiscal implications of the ECB’s bond-buying programme, Vox, 14 June 2013 http://www.voxeu.org/article/fiscal-implications-ecb-s-bond-buying-programme

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July 20, 2013 A Shuffle of Aluminum, but to Banks, Pure Gold By DAVID KOCIENIEWSKI MOUNT CLEMENS, Mich. — Hundreds of millions of times a day, thirsty Americans open a can of soda, beer or juice. And every time they do it, they pay a fraction of a penny more because of a shrewd maneuver by Goldman Sachs and other financial players that ultimately costs consumers billions of dollars.

The story of how this works begins in 27 industrial warehouses in the Detroit area where a Goldman subsidiary stores customers’ aluminum. Each day, a fleet of trucks shuffles 1,500-pound bars of the metal among the warehouses. Two or three times a day, sometimes more, the drivers make the same circuits. They load in one warehouse. They unload in another. And then they do it again. This industrial dance has been choreographed by Goldman to exploit pricing regulations set up by an overseas commodities exchange, an investigation by The New York Times has found. The back-and-forth lengthens the storage time. And that adds many millions a year to the coffers of Goldman, which owns the warehouses and charges rent to store the metal. It also increases prices paid by manufacturers and consumers across the country. Tyler Clay, a forklift driver who worked at the Goldman warehouses until early this year, called the process “a merry-go-round of metal.”

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Only a tenth of a cent or so of an aluminum can’s purchase price can be traced back to the strategy. But multiply that amount by the 90 billion aluminum cans consumed in the United States each year — and add the tons of aluminum used in things like cars, electronics and house siding — and the efforts by Goldman and other financial players has cost American consumers more than $5 billion over the last three years, say former industry executives, analysts and consultants. The inflated aluminum pricing is just one way that Wall Street is flexing its financial muscle and capitalizing on loosened federal regulations to sway a variety of commodities markets, according to financial records, regulatory documents and interviews with people involved in the activities. The maneuvering in markets for oil, wheat, cotton, coffee and more have brought billions in profits to investment banks like Goldman, JPMorgan Chase and Morgan Stanley, while forcing consumers to pay more every time they fill up a gas tank, flick on a light switch, open a beer or buy a cellphone. In the last year, federal authorities have accused three banks, including JPMorgan, of rigging electricity prices, and last week JPMorgan was trying to reach a settlement that could cost it $500 million. Using special exemptions granted by the Federal Reserve Bank and relaxed regulations approved by Congress, the banks have bought huge swaths of infrastructure used to store commodities and deliver them to consumers — from pipelines and refineries in Oklahoma, Louisiana and Texas; to fleets of more than 100 double-hulled oil tankers at sea around the globe; to companies that control operations at major ports like Oakland, Calif., and Seattle. In the case of aluminum, Goldman bought Metro International Trade Services, one of the country’s biggest storers of the metal. More than a quarter of the supply of aluminum available on the market is kept in the company’s Detroit-area warehouses. Before Goldman bought Metro International three years ago, warehouse customers used to wait an average of six weeks for their purchases to be located, retrieved by forklift and delivered to factories. But now that Goldman owns the company, the wait has grown more than 20-fold — to more than 16 months, according to industry records. Longer waits might be written off as an aggravation, but they also make aluminum more expensive nearly everywhere in the country because of the arcane formula used to determine the cost of the metal on the spot market. The delays are so acute that Coca- Cola and many other manufacturers avoid buying aluminum stored here. Nonetheless, they still pay the higher price. Goldman Sachs says it complies with all industry standards, which are set by the London Metal Exchange, and there is no suggestion that these activities violate any laws or regulations. Metro International, which declined to comment for this article, in the past has attributed the delays to logistical problems, including a shortage of trucks and forklift drivers, and the administrative complications of tracking so much metal. But interviews with several current and former Metro employees, as well as someone with direct knowledge of the company’s business plan, suggest the longer waiting times are part of the company’s strategy and help Goldman increase its profits from the warehouses. Metro International holds nearly 1.5 million tons of aluminum in its Detroit facilities, but industry rules require that all that metal cannot simply sit in a warehouse forever. At least 3,000 tons of that metal must be moved out each day. But nearly all of the metal

352 that Metro moves is not delivered to customers, according to the interviews. Instead, it is shuttled from one warehouse to another. Because Metro International charges rent each day for the stored metal, the long queues caused by shifting aluminum among its facilities means larger profits for Goldman. And because storage cost is a major component of the “premium” added to the price of all aluminum sold on the spot market, the delays mean higher prices for nearly everyone, even though most of the metal never passes through one of Goldman’s warehouses. Aluminum industry analysts say that the lengthy delays at Metro International since Goldman took over are a major reason the premium on all aluminum sold in the spot market has doubled since 2010. The result is an additional cost of about $2 for the 35 pounds of aluminum used to manufacture 1,000 beverage cans, investment analysts say, and about $12 for the 200 pounds of aluminum in the average American-made car. “It’s a totally artificial cost,” said one of them, Jorge Vazquez, managing director at Harbor Aluminum Intelligence, a commodities consulting firm. “It’s a drag on the economy. Everyone pays for it.” Metro officials have said they are simply reacting to market forces, and on the company Web site describe their role as “bringing together metal producers, traders and end users,” and helping the exchange “create and maintain stability.” But the London Metal Exchange, which oversees 719 warehouses around the globe, has not always been an impartial arbiter — it receives 1 percent of the rent collected by its warehouses worldwide. Until last year, it was owned by members, including Goldman, Barclays and Citigroup. Many of its regulations were drawn up by the exchange’s warehouse committee, which is made up of executives of various banks, trading companies and storage companies — including the president of Goldman’s Metro International — as well as representatives of powerful trading firms in Europe. The exchange was sold last year to a group of Hong Kong investors and this month it proposed regulations that would take effect in April 2014 intended to reduce the bottlenecks at Metro. All of this could come to an end if the Federal Reserve Board declines to extend the exemptions that allowed Goldman and Morgan Stanley to make major investments in nonfinancial businesses — although there are indications in Washington that the Fed will let the arrangement stand. Wall Street banks, meanwhile, have focused their attention on another commodity. After a sustained lobbying effort, the Securities and Exchange Commission late last year approved a plan that will allow JPMorgan Chase, Goldman and BlackRock to buy up to 80 percent of the copper available on the market. In filings with the S.E.C., Goldman has said it plans by early next year to store copper in the same Detroit-area warehouses where it now stockpiles aluminum. On Saturday, however, Michael DuVally, a Goldman spokesman, said the company had decided not to participate in the copper venture, though it had not disclosed that publicly. He declined to elaborate. Banks as Traders For much of the last century, Congress tried to keep a wall between banking and commerce. Banks were forbidden from owning nonfinancial businesses (and vice versa) to minimize the risks they take and, ultimately, to protect depositors. Congress strengthened those regulations in the 1950s, but by the 1980s, a wave of deregulation began to build and banks have in some cases been transformed into merchants,

353 according to Saule T. Omarova, a law professor at the University of North Carolina and expert in regulation of financial institutions. Goldman and other firms won regulatory approval to buy companies that traded in oil and other commodities. Other restrictions were weakened or eliminated during the 1990s, when some banks were allowed to expand into storing and transporting commodities. Over the past decade, a handful of bank holding companies have sought and received approval from the Federal Reserve to buy physical commodity trading assets. According to public documents in an application filed by JPMorgan Chase, the Fed said such arrangements would be approved only if they posed no risk to the banking system and could “reasonably be expected to produce benefits to the public, such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interests, or unsound banking practices.” By controlling warehouses, pipelines and ports, banks gain valuable market intelligence, investment analysts say. That, in turn, can give them an edge when trading commodities. In the stock market, such an arrangement might be seen as a conflict of interest — or even insider trading. But in the commodities market, it is perfectly legal. “Information is worth money in the trading world and in commodities, the only way you get it is by being in the physical market,” said Jason Schenker, president and chief economist at Prestige Economics in Austin, Tex. “So financial institutions that engage in commodities trading have a huge advantage because their ownership of physical assets gives them insight in physical flows of commodities.” Some investors and analysts say that the banks have helped consumers by spurring investment and making markets more efficient. But even banks have, at times, acknowledged that Wall Street’s activities in the commodities market during the last decade have contributed to some price increases. In 2011, for instance, an internal Goldman memo suggested that speculation by investors accounted for about a third of the price of a barrel of oil. A commissioner at the Commodity Futures Trading Commission, the federal regulator, subsequently used that estimate to calculate that speculation added about $10 per fill-up for the average American driver. Other experts have put the total, combined cost at $200 billion a year. High Premiums The entrance to one of Metro International’s main aluminum warehouses here in suburban Detroit is unmarked except for one toppling sign that displays two words: Mount Clemens, the town’s name. Most days, there are just a handful of cars in the parking lot during the day shift, and by 5 p.m., both the parking lot and guard station often appear empty, neighbors say. Yet inside the two cavernous blue warehouses are rows and rows of huge metal bars, weighing more than half a ton each, stacked 15 feet high. After Goldman bought the company in 2010, Metro International began to attract a stockpile. It actually began paying a hefty incentive to traders who stored their aluminum in the warehouses. As the hoard of aluminum grew — from 50,000 tons in 2008 to 850,000 in 2010 to nearly 1.5 million currently — so did the wait times to retrieve metal and the premium added to the base price. By the summer of 2011, the price spikes prompted Coca-Cola to complain to the industry overseer, the London Metal Exchange, that Metro’s delays were to blame.

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Martin Abbott, the head of the exchange, said at the time that he did not believe that the warehouse delays were causing the problem. But the group tried to quiet the furor by imposing new regulations that doubled the amount of metal that the warehouses are required to ship each day — from 1,500 tons to 3,000 tons. But few metal traders or manufacturers believed that the move would settle the issue. “The move is too little and too late to have a material effect in the near-term on an already very tight physical market, particularly in the U.S.,” Morgan Stanley analysts said in a note to investors that summer. Still, the wait times at Metro have grown, causing the premium to rise further. Current and former employees at Metro say those delays are by design. Industry analysts and company insiders say that the vast majority of the aluminum being moved around Metro’s warehouses is owned not by manufacturers or wholesalers, but by banks, hedge funds and traders. They buy caches of aluminum in financing deals. Once those deals end and their metal makes it through the queue, the owners can choose to renew them, a process known as rewarranting. To encourage aluminum speculators to renew their leases, Metro offers some clients incentives of up to $230 a ton, and usually moves their metal from one warehouse to another, according to industry analysts and current and former company employees. To metal owners, the incentives mean cash upfront and the chance to make more profit if the premiums increase. To Metro, it keeps the delays long, allowing the company to continue charging a daily rent of 48 cents a ton. Goldman bought the company for $550 million in 2010 and at current rates could collect about a quarter-billion dollars a year in rent. Metro officials declined to discuss specifics about its lease renewals or incentive policies. But metal analysts, like Mr. Vazquez at Harbor Aluminum Intelligence, estimate that 90 percent or more of the metal moved at Metro each day goes to another warehouse to play the same game. That figure was confirmed by current and former employees familiar with Metro’s books, who spoke on condition of anonymity because of company policy. Goldman Sachs declined to discuss details of its operations. Mr. DuVally, the Goldman spokesman, pointed out that the London Metal Exchange prohibits warehouse companies from owning metal, so all of the aluminum being loaded and unloaded by Metro was being stored and shipped for other owners. “In fact,” he said, “L.M.E. warehouses are actually prohibited from trading all L.M.E. products.” As the delays have grown, many manufacturers have turned elsewhere to buy their aluminum, often buying it directly from mining or refining companies and bypassing the warehouses completely. Even then, though, the warehouse delays add to manufacturers’ costs, because they increase the premium that is added to the price of all aluminum sold on the open market. The Warehouse Dance On the warehouse floor, the arrangement makes for a peculiar workday, employees say. Despite the persistent backlogs, many Metro warehouses operate only one shift and usually sit idle 12 or more hours a day. In a town like Detroit, where factories routinely 355 operate round the clock when necessary, warehouse workers say that low-key pace is uncommon. When they do work, forklift drivers say, there is much more urgency moving aluminum into, and among, the warehouses than shipping it out. Mr. Clay, the forklift driver, who worked at the Mount Clemens warehouse until February, said that while aluminum was delivered in huge loads by rail car, it left in a relative trickle by truck. “They’d keep loading up the warehouses and every now and then, when one was totally full they’d shut it down and send the drivers over here to try and fill another one up,” said Mr. Clay, 23. Because much of the aluminum is simply moved from one Metro facility to another, warehouse workers said they routinely saw the same truck drivers making three or more round trips each day. Anthony Stuart, a forklift team leader at the Mount Clemens warehouse until 2012, said he and his nephew — who worked at a Metro warehouse about six miles away in Chesterfield Township — occasionally asked drivers to pass messages back and forth between them. “Sometimes I’d talk to my nephew on the weekend, and we’d joke about it,” Mr. Stuart said. “I’d ask him ‘Did you get all that metal we sent you?’ And he’d tell; me ‘Yep. Did you get all that stuff we sent you?’ ” Mr. Stuart said he also scoffed at Metro’s contention that a major cause for the monthslong delays is the difficulty in locating each customer’s store of metal and moving the other huge bars of aluminum to get at it. When he arrived at work each day, Mr. Stuart’s job was to locate and retrieve specific batches of aluminum from the vast stores in the warehouse and set them out to be loaded onto trucks. “It’s all in rows,” he said. “You can find and get anything in a day if you want. And if you’re in a hurry, a couple of hours at the very most.” When the London Metal Exchange was sold to a Hong Kong company for $2.2 billion last year, its chief executive promised to take “a bazooka” to the problem of long wait times. But the new owner of the exchange has balked at adopting a remedy raised by a consultant hired to study the problem in 2010: limit the rent warehouses can collect during the backlogs. The exchange receives 1 percent of the rent collected by the warehouses, so such a step would cost it millions in revenue. Other aluminum users have pressed the exchange to prohibit warehouses from providing incentives to those that are simply stockpiling the metal, but the exchange has not done so. Last month, however, after complaints by a consortium of beer brewers, the exchange proposed new rules that would require warehouses to ship more metal than they take in. But some financial firms have raised objections to those new regulations, which they contend may hurt traders and aluminum producers. The exchange board will vote on the proposal in October and, if approved, it would not take effect until April 2014. Nick Madden, chief procurement officer for one of the nation’s largest aluminum purchasers, Novelis, said the situation illustrated the perils of allowing industries to regulate themselves. Mr. Madden said that the exchange had for years tolerated delays and high premiums, so its new proposals, while encouraging, were still a long way from solving the problem. “We’re relieved that the L.M.E. is finally taking an action that

356 ultimately will help the market and normalize,” he said. “However, we’re going to take another year of inflated premiums and supply chain risk.” In the meantime, the Federal Reserve, which regulates Goldman Sachs, Morgan Stanley and other banks, is reviewing the exemptions that have let banks make major investments in commodities. Some of those exemptions are set to expire, but the Fed appears to have no plans to require the banks to sell their storage facilities and other commodity infrastructure assets, according to people briefed on the issue. A Fed spokeswoman, Barbara Hagenbaugh, provided the following statement: “The Federal Reserve regularly monitors the commodity activities of supervised firms and is reviewing the 2003 determination that certain commodity activities are complementary to financial activities and thus permissible for bank holding companies.” Senator Sherrod Brown, who is sponsoring Congressional hearings on Tuesday on Wall Street’s ownership of warehouses, pipelines and other commodity-related assets, says he hopes the Fed reins in the banks. “Banks should be banks, not oil companies,” said Mr. Brown, Democrat of Ohio. “They should make loans, not manipulate the markets to drive up prices for manufacturers and expose our entire financial system to undue risk.” Next Up: Copper As Goldman has benefited from its wildly lucrative foray into the aluminum market, JPMorgan has been moving ahead with plans to establish its own profit center involving an even more crucial metal: copper, an industrial commodity that is so widely used in homes, electronics, cars and other products that many economists track it as a barometer for the global economy. In 2010, JPMorgan quietly embarked on a huge buying spree in the copper market. Within weeks — by the time it had been identified as the mystery buyer — the bank had amassed $1.5 billion in copper, more than half of the available amount held in all of the warehouses on the exchange. Copper prices spiked in response. At the same time, JPMorgan, which also controls metal warehouses, began seeking approval of a plan that would ultimately allow it, Goldman Sachs and BlackRock, a large money management firm, to buy 80 percent of the copper available on the market on behalf of investors and hold it in warehouses. The firms have told regulators that these stockpiles, which would be used to back new copper exchange-traded funds, would not affect copper prices. But manufacturers and copper wholesalers warned that the arrangement would squeeze the market and send prices soaring. They asked the S.E.C. to reject the proposal. After an intensive lobbying campaign by the banks, Mary L. Schapiro, the S.E.C.'s chairwoman, approved the new copper funds last December, during her final days in office. S.E.C. officials said they believed the funds would track the price of copper, not propel it, and concurred with the firms’ contention — disputed by some economists — that reducing the amount of copper on the market would not drive up prices. Others now fear that Wall Street banks will repeat or revise the tactics that have run up prices in the aluminum market. Such an outcome, they caution, would ripple through the economy. Consumers would end up paying more for goods as varied as home plumbing equipment, autos, cellphones and flat-screen televisions.

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Robert Bernstein, a lawyer at Eaton & Van Winkle, who represents companies that use copper, said that his clients were fearful of “an investor-financed squeeze” of the copper market. “We think the S.E.C. missed the evidence,” he said. Gretchen Morgenson contributed reporting from New York. Alain Delaquérière contributed research from New York. This article has been revised to reflect the following correction: Correction: July 20, 2013 A previous version of this article misstated one of the financial institutions that received approval to buy up to 80 percent of the copper available on the market. It is BlackRock, not the Blackstone Group. http://www.nytimes.com/2013/07/21/business/a-shuffle-of-aluminum-but-to-banks- pure-gold.html?_r=1&pagewanted=all&

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