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Número 102.2 ANEXO V

Alvaro Espina 17 Septiembre de 2014 Entre el 12 de junio y el 1 de julio ft.com comment Columnists July 1, 2014 6:59 pm Bad advice from Basel’s Jeremiah

By Martin Wolf The Bank for International Settlements’ proposals for post-crisis policy have serious flaws

©Ingram Pinn I admire the Bank for International Settlements. It takes courage to accuse its owners – the world’s main central banks – of incompetence. Yet this is what it has done, most recently in its latest annual report. It would be easy to dismiss this as the rantings of a prophet of doom. That would be a mistake. Whether or not one agrees with its pre- 1930s view of macroeconomic policy, the BIS raises big questions. Contrariness adds value. One can divide the BIS analysis into three parts: what caused the crisis; where we are now on the way out of it; and what we should do. More ON THIS STORY// Central banks urged to end loose policy/ BIS warns over ‘euphoric’ markets/ Business Blog Financial herd flees investment banking/ Bank of England Crashing the party/ Markets Insight Don’t bank on a comfortable rate ride ON THIS TOPIC// Forward guidance could ‘encourage risk’/ BIS warns over loose lending conditions/ On Monday Red flags wave over Asian corporate debt/ Trading in yen soars on ‘Abenomics’ drive MARTIN WOLF// No cause for complacency/ Defend Argentina from vultures/ Effects of climate fix/ UK has to be in or out of EU On the first, the perspective is that of the “financial cycle”. This analysis goes back to the work of the great Swedish economist Knut Wicksell at the turn of the 20th century. The core idea is that if the rate of interest is too low, a boom driven by expanding credit and rising asset prices may ensue. One of the crucial (and correct) implications is that credit and money are endogenous: they are created by the economy. When the financial cycle turns from boom to bust, crises erupt. Then follow the “balance sheet recessions” described by Richard Koo of the Nomura Research Institute – painful deleveraging and extended periods of feeble growth. Such cycles, argues the BIS, “tend to play out over 15 to 20 years on average”. To give credit where it is due, the BIS gave such warnings well before the crisis hit the high-income countries from 2007. On the second, the BIS notes that growth has picked up over the past year, with advanced economies gaining momentum, while emerging economies lose it. Nevertheless, recovery has been slow and weak in crisis-hit countries. While global growth is not far from rates seen in the 2000s, the shortfall in the path of gross domestic product persists. Meanwhile, overall indebtedness continues to rise. Crises, we are reminded, cast a long shadow. Furthermore, the policies of central banks are exerting extraordinary influence on financial markets, generating a “search for yield”, a disappearance of pricing for risk and a collapse in market volatility. This is true even though balance sheets remain so stretched. Meanwhile, credit excesses have emerged in a number of emerging economies. The BIS is particularly concerned about new sources of vulnerability in the latter, including foreign borrowing by non-financial corporates. Overall, concludes the BIS wryly, “it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments”. (See charts.)

It is on the third point – what is to be done – that the BIS turns into a prophet from the Old Testament: it demands austerity now. In countries that have experienced a financial crisis it recommends balance sheet repair and structural reform – deregulation, improved labour flexibility and “trimming public sector bloat”. It demands fiscal retrenchment. But unlike, say, George Osborne, the UK chancellor of the exchequer, the BIS wants to see monetary stimulus withdrawn, too, emphasising the risks of “exiting too late and too gradually”. It plays down both risks and costs of deflation, despite the huge overhang of debt that it also stresses. Even Jens Weidmann, the Bundesbank president, does not do that. Being more hawkish than the Bundesbank is quite something. Meanwhile, in countries that have experienced financial booms (the report points to Brazil, China and Turkey), it recommends pre-emptive monetary tightening and imposition of macroprudential restraints. To me, then, this is a blend of the wise, the foolish and the doubtful. Start with the doubtful. The BIS is right to emphasise the enormous costs of credit- driven booms. But it ignores the context in which policy makers allowed these to occur. In particular, it ignores the evidence of a global savings glut shown in low pre-crisis long-term real interest rates and huge net flows of capital from countries with good investment opportunities to countries with far worse ones. Similarly, it ignores the impact of adverse shifts in the distribution of income and in business behaviour on propensities to save and invest.

Again, the BIS insists that losses in output relative to trend are inevitable. There is no doubt that most crises end up with huge long-term losses. But, by the 1950s, the US had recovered fully from the gigantic losses relative to the pre-1929 trend in GDP per head caused by the biggest crisis of all: the Great Depression (see chart). Is this not because, unlike in the pusillanimous present, the US subsequently experienced the biggest fiscal stimulus ever – the second world war? I can imagine how the BIS would have warned against such fiscal irresponsibility. Turn, now, to the wise. First, the BIS is right to add to warnings over credit booms. Their joy is fleeting and the hangover agonising. This is particularly true for countries unable to borrow easily in their own currencies or without large holdings of foreign exchange reserves. Pre-emptive action is indeed required. Second, the BIS is right to emphasise the case for accelerating post-crisis recognition of bad debt and reconstruction of balance sheets of both borrowers and intermediaries. This process of deleveraging is nearly always too slow. Professors Atif Mian and Amir Sufi, of 3

Princeton and Chicago universities respectively, make much of this argument in their important book, House of Debt. Unfortunately, it is also politically difficult to make this process work.

Finally, consider the foolish. There is indeed an important argument to be had over the right balance to strike between fiscal and monetary reactions to financial crises. I believe we have relied too much on monetary policy, which does carry with it many of the risks the BIS rightly emphasises. But the notion that the best way to handle a crisis triggered by overleveraged balance sheets is to withdraw support for demand and even embrace outright deflation seems grotesque. The result, inevitably, would be even faster rises in real indebtedness and so yet bigger waves of bankruptcy that would lead to weaker economies and so to further increases in indebtedness. The reasons for abandoning the pre-Keynesian consensus were powerful, whatever the BIS (and many others) may think. The BIS is entitled to warn. Central banks should listen to it politely. But they must reject important parts of what it advises. http://www.ft.com/intl/cms/s/0/bf235058-00fc-11e4-a938- 00144feab7de.html#axzz36IQHvNpV

ft.com comment Columnists July 1, 2014 6:30 pm A British identity crisis has hobbled the No campaign

By John Kay The real question is whether Scots also feel loyal to the UK

©Getty The referendum on Scottish independence is now only two months away. Opinion polls have never shown a majority of the Scottish population ready to vote for secession. And most experience around the world of referendums on constitutional issues is that as the vote approaches, the electorate moves towards the status quo. But such a nervous reversion to the familiar has not happened in Scotland. If anything, support for independence has stabilised at about 40 per cent. The outcome will therefore depend on how reliably expressions of intention are translated into votes on the day. There is a possibility, although not a very strong one, of a Yes result for which no one either in London or in Scotland is really prepared. More ON THIS STORY// Scotland Yes camp losing battle, poll finds/ Tax take from oil and gas at decade low/ Forces do battle with tradition at Stirling/ Comment A secessionist lust/ Academic costs Scots Yes at £600m-£1.5bn ON THIS TOPIC// Scots scrap council tenants’ Right to Buy/ China premier opposes Scottish Yes vote/ Notebook Has Salmond already won?/ Gideon Rachman Political donations JOHN KAY// The NHS might not keep us alive/ Fine art and finance/ How to curb moral hazard/ No banking crises in Canada Although that is just an outside chance, it is now probable that the vote for independence will be large enough to keep the issue alive. John Curtice, the Scotland- based doyen of pollsters, offers an important insight into why matters stand as they are. The key to voters’ preference, he explains, is not whether they feel a strong sense of Scottish identity; the overwhelming majority of Scots do. The question is whether they also feel a strong sense of British identity. In that lies the source of the failure of the No campaign to make greater headway. Its tone has been predominantly negative. Gordon Brown, the former prime minister, has warned his fellow Scots to ponder the future of their pensions. Mark Carney, governor 5

of the Bank of England, and Sir Nicholas Macpherson, permanent secretary to the Treasury, have been called on to express worries about currency and banking. George Robertson, a Scottish former secretary of state for defence and secretary-general of Nato, told the country independence would be “cataclysmic” for the security of the west. But self-assertion is a common reaction to bullying, especially among Scots. The underdog resisting oppression with aggression, usually pointlessly, is a familiar theme of Scottish lore, from William Wallace to union leader Jimmy Reid’s doomed attempt in the 1970s to keep Upper Clyde Shipbuilders afloat. Scaremongering reinforces Scottish identity while undermining rather than reinforcing British identity. The underdog resisting oppression with aggression, usually pointlessly, is a theme of Scots’ historical myth So the failure of the No campaign is a failure to state powerfully what it means to be British. Perhaps that is because the leaders of that campaign have not been sure what they would say. Political leaders in France or Russia or the US – perhaps even Spain – would not encounter a similar problem. But Britishness has historically been bound up with empire and maritime dominance – both activities to which Scotland made disproportionate contributions. Now that these things have gone, it is hard to say what the multicultural United Kingdom of Great Britain and Northern Ireland represents. The usual mechanism for managing multiple identities is federation. But this is not an answer here, since England counts more than 80 per cent of the UK population and there is no real interest in establishing an English parliament. Yet without one there is no answer to the “West Lothian question”, the anomaly that allows Scottish MPs to vote on issues in England, while English MPs cannot vote on the same issues in Scotland because the relevant functions have been devolved. This problem is aggravated by the degree to which Scotland’s centre of political gravity differs from that of the rest of the UK. In the past two decades, Scotland has not sent more than one Conservative MP to Westminster, and a likely outcome of the 2015 general election is a Labour government that would lose its majority if Scotland became independent. Prime Minister David Cameron, like Margaret Thatcher before him, appears an alien figure in Scotland. His very accent emphasises that, despite his ancestry, he comes from a different place. It remains overwhelmingly likely that Scotland will vote in September to remain part of the union. But it is also more likely that the UK is sleepwalking towards disintegration – not in this vote but in the next. Political leaders were wrong to think they would bind the UK together through devolution, and they are probably wrong to believe giving more power to Edinburgh will now have that effect. These moves only strengthen the sense of a distinct Scottish identity. They need instead to make being British something to be proud of. http://www.ft.com/intl/cms/s/0/d5e365c2-010a-11e4-a938- 00144feab7de.html#axzz36IQHvNpV

ft. com World Europe July 1, 2014 3:03 pm ECB’s loan-buying plans stall By Claire Jones in Frankfurt

©Reuters The European Central Bank is yet to take any firm decisions on how it intends to revive the market for securitisation, despite a pledge last month to intensify efforts to reinvigorate an asset class branded as “toxic sludge” during the financial crisis. The eurozone’s top central bankers will gather in Frankfurt this week to discuss economic developments. But in spite of signs that the recovery is weakening, few expect any big policy change so soon after the ECB unveiled exceptional measures in June, including negative deposit rates and an offer of up to €400bn in cheap four-year loans.

Mario Draghi is, however, likely to face questions on whether officials have made progress on plans to buy bundles of business loans, sliced, diced and repackaged as asset-backed securities. The ECB president promised after the governing council’s June vote that officials would “intensify preparatory work” on a programme of purchases of ABSs backed by loans to the currency bloc’s companies. Any programme the ECB does eventually undertake is likely to be much smaller than the mass buying of government bonds that policy makers have pledged to conduct 7

should inflation remain excessively low. Analysts believe the size of the programme would be in the tens of billions, while its structure could resemble the covered bond purchase scheme, when the ECB bought €100bn of securities over three years between 2009 and 2012 in both primary and secondary markets. Officials in three of the central bank’s directorates – market operations, legal and risk management – are working on the securitisations programme. But firm details on its design remain scant. One reason for that is the difficulty in buying assets in a market that remains more or less dead. More ON THIS TOPIC//The Macro Sweep US housing booms as Japan loses momentum/ Eurozone inflation holds steady in June/ Eurozone bond rally nears high- water mark/ Too soon to celebrate loan parcel revival IN EUROPE// French in fresh move on Calais migrants/ Sarkozy under formal investigation/ Erdogan looks for presidency/ Vatican bank chairman to step down “The problems are many,” said Dave Covey, head of European ABS strategy at Nomura. “If it was that easy for the ECB to buy asset backed securities, they would have done it already.” Mr Draghi’s June pledge was the latest in a series of statements by top ECB officials expressing their desire to restart the market. It has been dormant since 2008, when defaults on opaque, complex forms of securitisation backed by subprime US mortgage loans, triggered widespread panic in global markets. Last month, the central bank joined forces with the Bank of England to promote the issuance of simpler forms of securitisations. It has also called for the relaxation of regulatory rules on high-quality ABSs. The ECB views simpler, plain vanilla forms of securitisation as a means to make the eurozone’s financial system more stable by reducing the concentration of risk in the banking sector. It could also restore lending to the bloc’s credit-starved smaller businesses. “The goal is to shift risk from banks to capital markets,” said Mr Covey. “The ECB cares about the ABS market because it produces a more resilient financial system.” The goal is to shift risk from banks to capital markets. The ECB cares about the ABS market because it produces a more resilient financial system - Dave Covey, Nomura But while default rates on European securities have been far lower than instruments backed by US loans, banks have shown little interest in issuing them. Issuance waned by more than a quarter between 2012 and 2013, to just €181bn, according to AFME, a trade body, with less than half of this placed with investors. In the first quarter of this year, just €13.6bn was issued. Investors are already keen to snap up the better-quality tranches of ABSs, while less than a tenth of the issuances outstanding are backed by SME loans. Katherine Frey, Europe, Middle East and Africa head of structured finance at Moody’s, a credit-rating agency, said: “A key ingredient missing is origination of loans from banks.”

Some consider the barriers to reviving securitisation as at least partly of the central bank’s own making. The ECB has hinted that it will keep rates at their current record lows at least until late 2016. Last month it bolstered its forward guidance offering cheap fixed-rate loans for at least another two years. These moves have made funding through other means – including securitisation – less attractive. “The banks are not using securitisation because they can get cheaper funding elsewhere,” Mr Covey said. http://www.ft.com/intl/cms/s/0/4f475e4a-006c-11e4-9a62- 00144feab7de.html#axzz36IQHvNpV

¿Qué hacemos con las indemnizaciones por despido? Una posible reforma de la regulación de las indemnizaciones estaría más que justificada Pablo Gimeno 30/06/2014 - 20:43h El modelo actual La reforma del régimen de indemnizaciones por despido ha sido un tema tabú hasta la reforma laboral de 2012. Afirmar que hace falta una modificación del sistema se asimila casi automáticamente a posturas neoliberales, desreguladoras o que tienen como única finalidad el abaratamiento del despido. Sin embargo, lo cierto es que nuestro sistema no funciona, y en parte (no sólo) esto se debe a una pésima regulación de las indemnizaciones, que no se resuelve con las propuestas que hasta la fecha se han planteado.

Fuente: EPA/Eurostat La necesidad de una reforma está sin embargo más que justificada, y no porque los costes del despido generen necesariamente desempleo. Los defectos del régimen son varios, pero se pueden resumir en cuatro: obligar a realizar fuertes desembolsos a empresas en crisis puede agravar su situación; fomenta la contratación temporal; a menudo trata peor al empresario que cumple la ley que al que la ignora; y, finalmente, altera la decisión de qué trabajador será despedido. El primero de estos problemas no requiere mucha explicación, y los dos siguientes pueden entenderse también con facilidad si se tiene en cuenta que un despido por causas objetivas (económicas o de otro tipo) conlleva, junto con la indemnización (20 días de salario por año de servicio) otros costes, tales como los de procedimiento 10

(documentación y justificación de las causas, negociación y consulta con los representantes de los trabajadores), incertidumbre (riesgo de que sea impugnado) o gastos adicionales (convenios especiales de Seguridad Social, aportaciones al tesoro por la enmienda telefónica, planes de recolocación). Por ello, cuando el trabajador sea fácilmente reemplazable la empresa optará por la contratación temporal, con un coste cierto pero reducido (a partir del próximo año, 12 días de salario por año de servicio). Cuando la experiencia en el puesto o la escasez de trabajadores con determinada cualificación hagan más interesante el contrato indefinido, el empresario optará por el reconocimiento de la improcedencia aun cuando concurra una causa legal para el despido. Debe tenerse en cuenta que si el contrato no ha sido demasiado extenso, la escasa diferencia de 13 días por año que hay entre el despido procedente e improcedente será menor que los costes asociados al despido procedente. El último de los problemas indicados, que se dará en cualquier sistema en que el empresario pague en el momento del despido una cantidad creciente con la antigüedad, se debe a que un trabajador que lleve tiempo en la empresa será más caro de despedir que el más reciente (especialmente si es temporal). Esto no sólo supone que el despedido pueda no ser el peor trabajador para la empresa, sino que la sensación de “blindaje” puede reducir el interés por la actualización de los trabajadores de más edad. Con el tiempo estos corren el riesgo de quedar obsoletos, lo que justificará que muchos despidos colectivos se concentren en ellos, quienes además tendrán un elevado riesgo de convertirse en parados de larga duración. El contrato único En 2010 se propuso el llamado contrato único, de indemnizaciones crecientes o para la igualdad de oportunidades, que ha suscitado numerosas críticas y ha tenido escasa aceptación entre políticos y agentes sociales, pero ha recibido notable atención en distintos ámbitos, e incluso ha tomado forma de proposición de ley (rechazada). Lo que proponen los economistas es, básicamente, eliminar las modalidades de contratación y establecer una indemnización que aumenta con la antigüedad, entre 8 y 20 días si es procedente y entre 12 y 33 si es improcedente.

Este sistema elimina la diferencia de coste entre temporales e indefinidos, lo que resulta acertado, pero mantiene muchos de los problemas del modelo actual, como son los derivados del crecimiento de la indemnización con la antigüedad del trabajador. De este modo, los más recientes sufrirían una rotación constante, por lo que no se alteraría la temporalidad estructural. Por otra parte, la reducción generalizada de los niveles de indemnización hace que la propuesta tenga una escasa viabilidad política, al tiempo que agrava el problema de la prácticamente nula penalización de la improcedencia. A título de ejemplo, en el caso de un trabajador con cinco años de antigüedad, a pesar del abaratamiento de la reforma de 2012, la diferencia entre el despido procedente e improcedente es de 65 días de salario, mientras que con el contrato de indemnizaciones crecientes sería tan sólo de 30 días. El modelo austriaco o de capitalización de la indemnización La segunda alternativa que se ha tomado en cuenta para España ha sido la importación del llamado modelo austriaco. Este consiste simplemente en la sustitución de las indemnizaciones a los despedidos por aportaciones empresariales, realizadas durante toda la relación laboral, a un fondo creado a nombre de cada uno de los trabajadores. El importe acumulado (junto con los intereses que genere) pertenece desde este momento al trabajador, aunque sólo se genera el derecho al cobro, como regla general, en el momento del despido o de la jubilación. Este modelo tiene importantes ventajas: otorga una certeza total sobre los costes al empresario; no le obliga a tener que hacer un gasto adicional en momentos de crisis; es neutral en relación a la temporalidad; el trabajador cobrará aunque el empresario sea insolvente en el momento del despido (la gestión del fondo es ajeno a la empresa); y, finalmente, podrá cambiar de trabajo sin perder los derechos asociados a la antigüedad.

Sin embargo, tampoco este sistema es la panacea. El hecho de que el despido sea totalmente gratuito para el empresario puede provocar un número excesivo de estos, 12

pues ante una situación adversa de la empresa, otras alternativas (como ajustar la forma de producir de la empresa o modificar condiciones de trabajo) sí serán costosas. Además, aunque se diseñe de modo que mantenga constantes los costes asociados al despido, se producirá una redistribución que favorecerá a aquellas compañías que más despiden y más usan de la temporalidad, penalizando a aquellas con plantillas más estables. Resulta por todo ello acreditado que ni el modelo vigente es adecuado, ni las alternativas que se han propuesto suficientes. Se trata de un debate abierto en el que considero que pueden y deben realizarse contribuciones, como trataré de hacer en este mismo lugar próximamente. http://www.eldiario.es/agendapublica/impacto_social/hacemos-indemnizaciones- despido_0_276472924.html

Daily Morning Newsbriefing July 01, 2014 Return of the banking crises -Portugal edition The plan to protect the Banco Espirito Santo's (BES) from the serious financial problems of its founding family holding, the Espirito Santo group, did not convince investors, and triggered increases in Portuguese sovereign yields across the maturity spectrum. The BES shares lost 15.4% in just week, 40% since a €1.05bn share sale on June 11. The cost of credit default swaps on BES rose from 192 to 318bp during this period. The yield on the bank’s five-year bond rose to 4.256%. The decline in shares was so sharp that Portugal's market regulator announced late Monday it would ban naked short-selling of shares in BES and Espirito Santo Financial Group, the holding company of the Espirito Santo family, Reuters reports. There are first signs of contagion effects, pushing government bond yields higher across the maturity spectrum, writes Jornal de Negocios. 10y bond yields rose 8.6bp to 3.652% on Monday, 2y bond yields increased 3.8bp to 0.897% and 5y grow 6.2bp to 2.356%. The Bank of Portugal has already sought to impose measures that isolate BES risk of contagion. Facilitating access to liquidity is another way for the BoP to support BES if pressure on the banks liquidity continues to rise. Under the worst case scenario, the BES might have to ask for state report. There is another €6.4bn still available in the bank rescue fund. Although there is little reason to doubt the solvency of the bank itself, uncertainty about the management, internal wars and fears about the impact that the financial situation of the GES holding can still bring down the BES even with "ring fencing" in place, warns Andre Verissimo in Jornal de Negocios. The scandal began with the controversy over the BES selling bonds from a financially troubled company linked to the founding family to retail customers, according to Reuters. The crisis saw Portugal's only banking dynasty lose control of the bank as its patriarch stepped down as chief executive. It is still too early to tell whether this crisis turns the "healthy" BES into a bank in need of a bailout. But if it happens there is a resemblance with the Bankia crisis, which ended with the Spanish government bailing out the Bankia's holding group BFA rather than saving just the bank for a fraction of the costs. That may happen here too. … and Bulgaria edition The FT reports that the European Commission sanctioned a Lev3.3bn (€1.7bn) emergency credit line for two Bulgarian banks – First Investment Bank and Corporate Commercial Bank – which were subject to a bank run last week. Bank shares and bonds 14

recovered after the news of the credit line. The article quotes the European Commission as saying that the Bulgarian banking sector was well-capitalised, and had similar levels of liquidity than its peers in other member states. It also quoted an an analyst as saying that this bank run was very different from a bank run in Slovenia, where fundamentals had played a role. In the Bulgarian case, the destabilisation was due to a cyber attack via SMS. Another set of dreadful economic data For us, the key data to watch out for at the moment are any signs of a pick-up in eurozone core inflation, of an economic recovery in Italy, and of credit. Yesterday’s data disappointed on all three fronts. Most disturbing was the monthly forecast by Istat, the Italian statistics office, which said the recovery has not yet started, and said it would not happen this year. After the fall in GDP of 1.9% last year, Istat now sees GDP going up in band from -0.1 to 0.3% this year, against the government’s own forecast of 0.8%. This is a very big deviation, and will almost certainly have significant fiscal effects. Inflation rates are still falling, and Istat now estimates that the trend growth rate of prices at 0.3%. The all-items HICP inflation rate for the eurozone came in at disappointing 0.5% for June, with the core rate up slightly for 0.7% to 0.8%, according to Eurostat. The core rate has been fairly stable at around this level for eight months, and constitutes a stable indicator of overall price developments. Various media reports pointed out that the June 5 decision have not had an effect on inflation yet – but then how could they? The third important set of data, the Monetary Developments, confirmed that the eurozone remains stuck where it was before. M3 growth in June was up from 0.7% to 1% - still within the fluctuation band of the last few months - loans to the private sector were down by 2% annually. The rate of decline in business loans was down, but in June this was compensated for by an increase in the decline of household loans, including mortgages. These data give us a very consistent snapshot of where the eurozone economy stands today. The economic recovery has not started, and the monetary/credit side of the economy remains acutely depressed. On inflation, the measure to watch out for is core inflation, which has been rock-solid in a range of 0.7/1% since November last year. Core inflation is a good forward indicator, and the longer these rates are stuck at level of “below but close to 1%”, the greater the probability that this level proves persistent. In Italy, there has been no “Renzi effect” whatsoever. These data also mean that the deficit is likely to overshoot badly, and that debt-to-GDP is now heading firmly towards 140% and higher before coming down. Slovakia's fiscal boost for small income households The Slovak Prime Minister Robert Fico Slovakia's said his government will raise the minimum wage and cut household gas prices as part of a €250m package for poorer households (This is about 0.3% of GDP), Reuters reports. As part of the package, the government said people with lower wages - about 800,000 in the nation of 5.5m - would pay lower payroll charges, a quasi-tax including health and social insurance. Fico said he would raise pensions and subsidise train tickets for students, pensioners and

commuters. The government will also cut natural gas prices by at least 10% in the coming two years. Slovakia has overcome the euro zone debt crisis with fewer bruises than many other countries in the currency bloc. After years of austerity, the economy has been accelerating, boosting tax revenue. Last week, the Finance Ministry raised its 2014 tax revenue forecast by €290m, or about 0.4% of GDP. It expects the economy to grow by 2.3% this year and 3.0% in 2015. Don’t bet on a European securitisation market The Cecchetti and Schoenholtz blog has a very useful article on securitisation, explaining why a revival of the securitisation market in Europe is very unlikely to happen on a grand scale. They make the argument that the growth in US securitisation was ultimately based on an implicit guarantee to government-sponsered entreprises such as Fannie Mae and Freddy Mac. Since the eurozone governments cannot even forge a banking union with cross-border guarantees, they will be even more reluctant to provide guarantees for a securitisation market. They argue that it will be extremely difficult to jumpstart a securitisation market without a government guarantee. Will June 5 stabilise Eonia? Francesco Papadia is taking a closer look at the effects of the June 5 decisions by the ECB’s governing council on Eonia, and finds that they will have an uncertain impact on the “cobweb” pattern, a model to describe the inherent instability of those overnight money market rates. His estimate for excess liquidity in the system is some €100bn- 150bn, which is too low for comfort. Here is his conclusion: “I am not sure, however, we can exclude that there would continue to be occurrences of the ‘cobweb pattern’, whereby banks behaviour will introduce waves in excess liquidity demand and therefore in Eonia. This can be generated by the fact that, unless liquidity is very abundant (say higher than 150bn), when market rates are low, banks borrow from the market rather than from the ECB but, by not drawing liquidity from the central bank, banks reduce excess liquidity and this will tend to raise money market rates, but then, when market rates are high banks will again borrow more from the ECB and thus inject liquidity and thus lower rates and so on...” Schieritz on the BIS Mark Schieritz takes a swipe at the conservatism of the Bank for International Settlements (see their annual report yesterday). He says it could have been written by the Bundesbank. The BIS understands this crisis as a balance sheet recession. But why should macroeconomic policy not work in such a circumstance? Why should one necessarily conclude that fiscal policy is ineffective? What struck as puzzling is the BIS’ unbridled optimism on inflation. If you start with a framework of a Richard Koo-style balance sheet recession – which is probably a good starting point – should one not at least consider the possibility of a persistent fall in the inflation rate, which is what happened during Japan’s great balance sheet recession? As Koo has pointed out many times in the context of Japan, and as Schieritz argues in his piece, fiscal policy can become very powerful in those episodes. What strikes us about the BIS’ framework is not so much their conservatism (they are central bankers after all), but their inconsistency. This is neither neo-Classical, nor Keynesian, nor Monetarist. There may indeed be some parallels between the BIS and the 16

Bundesbank. German conservatives embraced monetarism when it coincided with their world-view, and dumped it when that was no longer the case. This is why in Germany today almost nobody cares about low M3 growth rates, while pretending to be worried about asset prices, or whatever else would allow them to raise interest rates. Perhaps the BIS could enlighten us about the nature of its analytical framework. At least then, we could have a proper discussion. Adair Turner on credit demand vs supply Adair Turner has a very useful contribution to the debate on whether the fall in credit in the eurozone is supply or demand-side driven. He looks at the latest ECB monthly bulletin and finds that major progress has been achieved in fixing some of the supply- side problems, citing multiple indicators of credit availability and pricing. Yet the decline in private sector loans has accelerated over the last year. Despite the ECB’s own evidence, the policy focus remains on fixing the credit supply problem, through AQR and stress tests, and through TLTRO. We agree with his conclusion: “That reflects a recurring tendency in official policy debates, particularly in the eurozone, to concentrate on fixable problems to the exclusion of more difficult issues. The consequence of this approach, he writes, would be a Japanese style lost decade. Eurozone Financial Data 10y spreads

Previous This Yesterday day Morning France 0.342 0.347 0.346 Italy 1.462 1.489 1.481 Spain 1.386 1.420 1.412 Portugal 2.336 2.433 2.451 Greece 4.683 4.732 4.71 Ireland 1.088 1.117 1.111 Belgium 0.455 0.454 0.451 Bund Yield 1.26 1.248 1.256

exchange rates This Previous morning Dollar 1.365 1.3683

Yen 138.370 138.83

Pound 0.802 0.8001

Swiss Franc 1.215 1.2145

ZC Inflation Swaps previous last close

1 yr 0.74 0.75

2 yr 0.85 0.85

5 yr 1.22 1.21

10 yr 1.65 1.76

Eonia

27-Jun-14 0.04

26-Jun-14 0.04

25-Jun-14 0.04

24-Jun-14 0.04

OIS yield curve 1W 0.026 15M 0.047 2W 0.035 18M 0.048 3W 0.043 21M 0.059 1M 0.051 2Y 0.074 2M 0.054 3Y 0.145 3M 0.083 4Y 0.251 4M 0.065 5Y 0.376 5M 0.055 6Y 0.538 6M 0.063 7Y 0.705 7M 0.063 8Y 0.869 8M 0.062 9Y 1.020 9M 0.060 10Y 1.157 10M 0.059 15Y 1.646 11M 0.058 20Y 1.869 1Y 0.058 30Y 1.965

Euribor-OIS Spread previous last close

1 Week 2.243 1.743

1 Month 3.700 3.6

3 Months 11.671 10.971

1 Year 37.329 38.129

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-07- 01.html?cHash=457eb2bd425f576ffc3258c69b4b685b

How securitization really works June 30, 2014 In the winter of 1997, musician David Bowie issued $55 million worth of bonds backed by royalty revenue from 287 songs he had written and recorded before 1990. The bonds had a 10-year maturity, a Moody’s A3 rating, and a 7.9% interest rate (at the time, the 10-year Treasury yield was around 6.5%, so the spread was relatively modest). “Bowie bonds” were no accident: by the late 1990s, the U.S. financial system had evolved to the point where virtually any payment stream could be securitized. The success of U.S. securitization – as an alternative to bank finance – is a key factor behind the current push of euro-area authorities to increase securitization. The other key driver is the concern in Europe that many borrowers will remain starved for finance. Because finance is predominantly bank based in Europe – and banks faced heightened capital requirements – governments and potential borrowers are anxious to shift at least some financing into capital markets (including bonds and equities). European policymakers are fond of noting that European finance is 80 percent bank based and 20 percent market based, while the U.S. pattern is the reverse. (This may be a slight exaggeration: recent World Bank numbers for the euro area are closer to 60/40, while the U.S. pattern is indeed about 20/80.) Yet, emulating American securitization may require doing something most Europeans don’t realize. It probably means providing government guarantees at a scale that people currently do not envision. The reluctance of the financially healthiest euro-area countries to forge a euro-area banking union suggests that they also will resist large collective guarantees for a securitization market. To see what we mean, we can look at a few numbers regarding U.S. securitization. According to the Federal Reserve’s flow of funds statistics (the Z.1 release), total securitization stood at $9,360.4 billion as of end-March 2014, the latest reading (see chart below). But government-backed securitizations – these are mortgages, student loans and the like – accounted for $7,721 billion of this total (shaded in blue in the chart). That is, only 18% of U.S. securitization – primarily auto loans and credit card debt – are free from government guarantees! Even at the peak of private-sector securitization in mid-2007 – before the financial crisis grew intense – the government- backed share exceeded 60%. Securitized Liabilities in the United States (U.S. Dollars in Trillions)

Source: FRB Z.1 (flow of funds) and authors’ calculations. Government-backed securities include GSE credit market liabilities, agency- and GSE-backed mortgage pools, and securities of budget agencies. Other securitizations include the liabilities of ABS issuers and open market paper issued by chartered depositories. To put these numbers into perspective, we can look at another part of the U.S. financial system: insured bank deposits. You may be surprised to learn that (again, as of end- March 2014) only $6,094 billion out of $9,922 billion in bank deposits are insured. That is, 61% of bank deposits are government backed (see chart below) versus 82% of securitizations. Share of Deposits in Domestic U.S. Bank Offices Insured by FDIC

/> Source: FDIC Quarterly Banking Profile (balance sheet) time series. We believe that U.S. government backing of securitizations can (and should) be scaled back to allow for greater private participation in the mortgage market. Indeed, and in contrast to current U.S. policy, we generally share the view that the U.S. government- sponsored enterprises (GSEs) should be wound down within a few years. Nevertheless, it also seems difficult to jumpstart a large-scale securitization market in Europe without sizable public support. To be sure, the federal backstop for the U.S. GSEs became explicit only when these organizations faced a run on their liabilities in the summer of 2008. Previously, it was the credibility of the implicit backing from the 20

U.S. federal government that allowed the GSEs to borrow at low cost despite massive leverage. Yet, achieving such credibility without explicit agreement is more difficult in the euro area precisely because core euro-area governments wish to limit the financing burdens they share with the governments in the financially fragile periphery. The bottom line: If the euro area wishes to get securitization going in a big way, it will still need more of the mutual insurance among nations that has been so difficult to achieve. That doesn’t seem to be in the cards for now. http://www.moneyandbanking.com/commentary/2014/6/30/how-securitization-really- works The Authors

Stephen G. Cecchetti is Professor of International Economics at the Brandeis International Business School. He previously taught at Brandeis from 2003 to 2008. Before rejoining Brandeis in 2014, Cecchetti completed a five-year term as Economic Adviser and Head of the Monetary and Economic Department at the Bank for International Settlements in Basel, Switzerland. He also served as Director of Research at the Federal Reserve Bank of New York from 1997 to 1999, taught at the New York University Leonard N. Stern School of Business in the mid-1980s, and was a member of the Department of Economics at The Ohio State University.

Kermit L. Schoenholtz is Professor of Management Practice in the Department of Economics of New York University’s Leonard N. Stern School of Business, where he teaches courses on financial crises, money and banking, and macroeconomics. He also directs NYU Stern’s Center for Global Economy and Business. Schoenholtz was Citigroup’s global chief economist from 1997 until 2005. After a year’s leave, he served until 2008 as senior adviser and managing director in the Economic and Market Analysis (EMA) department at Citigroup. Schoenholtz joined Salomon Brothers in 1986, working in their New York, Tokyo, and London offices. In 1997, he became chief economist at Salomon, after which he became chief economist at Salomon Smith Barney and later at Citigroup.

ft.com Comment Analysis June 29, 2014 5:23 pm US economy: The productivity puzzle By Robin Harding Long-term prosperity depends on the capacity of every American to increase output constantly. Can they?

©Alamy Bumper crop: the success of US farmers in increasing their productivity is a model that some, such as MIT’s Erik Brynjolfsson, think can be replicated To glimpse the miracle of productivity growth there is nowhere better to look than the bountiful fields of the US Corn Belt. A hundred years ago, an army of farmers toiled to produce 30 bushels an acre; now only a few hands are needed to produce 160 bushels from the same land. The rise of modern civilisation rested on this trend: for each person to produce ever more. For the past 120 years, as if bound by some inexorable law, output per head of population increased by about 2 per cent a year. That is, until now. More ON THIS STORY// Outlook US jobs data set to show rebound/ Winter and healthcare hit US growth/ Economic activity has rebounded, says Fed/ The Macro Sweep US productivity and output fall IN ANALYSIS// Chile Limits to growth/ Telecoms – Scrambled signal/ Share trades Murky pools/ Karachi Under siege There is a fear – voiced by credible economists such as Robert Gordon of Northwestern University – that 2 per cent is no law but a wave that has already run its course. According to Prof Gordon’s analysis, 2 per cent could easily become 1 per cent or even less, for the next 120 years. The US Federal Reserve is already edging down its forecasts for long-term interest rates. “The most likely reason for that is there has been some slight decline . . . of

projections pertaining to longer-term growth,” said Janet Yellen, chairwoman, at her most recent press conference.

Yet there are also techno-optimists, such as Erik Brynjolfsson and Andrew McAfee of the Massachusetts Institute of Technology, whose faith in new discoveries is such that they expect growth to accelerate, not decline. Then there are more phlegmatic economists, whose answers are less exciting but also less speculative – and come in a bit below 2 per cent for growth in output per head. The productivity question is of the greatest possible consequence for the US economy, affecting everything from when interest rates should rise to where they should peak, from the sustainability of US debt to what is the wisest level of investment for every business in the country. The answer depends on companies such as Climate Corporation, which fights the battle for agricultural productivity growth from its new front line, in the office buildings of Silicon Valley. Climate Corporation, which was bought last year by Monsanto for $930m, works on “precision agriculture”, bringing the power of data science to bear on farming. For example, the company says that by combining fertiliser use, soil type, weather data and other information in a single database, it can tell farmers exactly how much nitrogen is in a field and thus how much fertiliser they need to apply. The boost to yields could be as much as 5 per cent – and that is just the start. “We’ve identified about 40 different decisions a farmer makes where there’s potential to apply data science,” says Anthony Osborne, the company’s head of marketing.

Whether computers can keep making broad contributions to productivity is one of the most important immediate issues. But it is not the only issue. Growth in gross domestic product, the familiar statistic by which all economies are measured, can come about in several ways: more workers, with better skills; more capital such as factories, roads and machines, or new technology. Leaving aside the latter category, the consensus among economists is that most of these will not contribute as much to economic growth as they have in the past. To start with, US population growth is at its lowest since the 1930s, having fallen from about 1.2 per cent a year in the 1990s to 0.7 per cent in recent years. This does not affect growth in living standards – it means fewer consumers as well as fewer workers – but adding less extra labour will slow the headline GDP growth rate that the Fed worries about. On top of that, demographics will also slow growth in GDP per capita, which does affect living standards. Ageing will mean fewer active workers per head of population; most women have now joined the US labour force so that source of extra workers is running out. Prof Gordon estimates that demographics could knock 0.3 percentage points off the long-run trend of 2 per cent growth. “Everybody is pretty much in agreement in expecting slower growth in hours worked relative to what we’ve seen in the last 50 years,” says John Fernald, a senior research adviser at the Federal Reserve Bank of San Francisco. The truest measure of economic progress, though, is the growth of GDP per hour worked. For every hour of human toil, how much is created? Here too, some factors that drove growth in the past are weakening, such as skills and education. The expansion of primary, then secondary and then college education has helped the economy grow for generations, but average years of education have now reached a plateau. “The US is slipping back in the league tables of college completion and high school completion,” says Prof Gordon, suggesting this will account for another 0.2 percentage points off per capita growth. That leaves technology. “I agree with much of what he says about the slowing demographics,” says Prof Brynjolfsson. “Where he and I differ is prospects for future innovation.” Growth in GDP per hour worked depicts an interesting pattern over time. According to Prof Gordon, at a rate of 2.4 per cent, it was fast from the 19th century until 1972. It then slowed to 1.4 per cent a year until 1996. The internet boom pushed the rate up to 2.6 per cent – it was this period that led Alan Greenspan, former Fed chairman, to talk about a “productivity feast” – but by 2004, well before the financial crisis, the surge was over. Since 2004, barring a measurement problem, growth in output per hour has been 1.3 per cent. Whether it’s robotics or software for knowledge work, if you take the labour input to zero you get a pretty astronomical productivity number The dispute is this: in the coming decades, should we expect growth like that which we experienced from 1996 to 2004, at 2.5 per cent, or like the period since 2004, of 1.3 per cent? While Prof Brynjolfsson has Star Trek visions of utopian technological progress, 24

Prof Gordon is more of a cyberpunk, imagining a world in which the computers may become more powerful but living standards for average humans improve only slowly. Computation is the root of Prof Brynjolfsson’s optimism: his book with Prof McAfee is called The Second Machine Age and argues that the impact of information technology has only just begun to be realised. Exponential expansion in computing power, and the ability to diffuse innovations rapidly, could mean growth like that of the late 1990s. “The reason I’m optimistic is that I don’t rely primarily on extrapolating past economic trends,” says Prof Brynjolfsson. After visiting labs, he says, “I just come away astonished at what’s in the pipeline. Most of it has not yet reached commercialisation.” Rather than referring to historical data, he points to Google’s self-driving car, to the potential for computer systems that diagnose disease and answer legal queries, and the growing flexibility of robotics. Such automation will free up a host of labour for new tasks, just as other innovations did in the past. “Whether it’s robotics or software for knowledge work, if you take the labour input to zero you get a pretty astronomical productivity number,” he says. By contrast, Prof Gordon expects a lower pace of productivity growth, perhaps in line with that achieved in the past 10 years. To hit even that target, he points out, means keeping up a steady stream of new creations such as smartphones. The heart of his argument is that the discoveries of the past – running water, the internal combustion engine, the electric lightbulb – were simply more important than those of today. From 1870 to 1972, he points out, American homes went from lightless, isolated places of drudgery to buildings of air-conditioned comfort, with a dishwasher in the kitchen and a car in the garage. Think of every employee you’ve had contact with in the last two or three days, and think, is that person going to be replaced by a robot in the next 20 years? Prof Gordon is also dismissive of the potential productivity gains from inventions such as driverless cars: being able to answer email instead of turning the steering-wheel, for example. “The real productivity gains would presumably come from driverless trucks,” he says, but then points out that a UPS delivery van would still need a driver to remove the parcels from the vehicle. He is more impressed by the potential of robotics but less convinced the moment has arrived when they are sufficiently powerful to supplant humans. “Think of every employee you’ve had contact with in the last two or three days, and think, is that person going to be replaced by a robot in the next 20 years?” One curious aspect of both professors’ arguments is how uneconomic they are. Their focus is more about what is left to discover than the economy’s ability to make those discoveries. Prof Gordon’s approach would struggle to explain the 1996 acceleration in productivity growth, while Prof Brynjolfsson’s has little to say about the slowdown after 2004. Yet economics has quite a lot to say about the process of making discoveries, based on the less than revolutionary insight that breakthroughs depend on the effort put into researching them.

In a recent study, Mr Fernald and Charles Jones of Stanford University break down the inexorable 2 per cent growth in US output per person from 1950 to 2007 in a different way. They find almost none of it comes from more capital per worker. About 0.4 percentage points comes from human capital (better education). But by far the largest contribution – 1.6 percentage points of the total – comes from the fact that more people are working on research and development. To sustain that magical run of 2 per cent growth in output per person, the US may need more Silicon Valleys to emerge in China and India In part, that is because there are more people (and thus more bodies to do research). But mainly it is the result of devoting a steadily larger portion of the total population to work on research and development. This analysis allows for a more grounded forecast than speculation about what technologies remain to invent. “The pessimistic part of that equation for the future is human capital,” notes Mr Fernald, as the contribution from better education is petering out. It is also impossible for the US to keep devoting ever more of its population to working in research and development. But this is not true of the world as a whole. Huge populations in China, India and elsewhere are joining the global economy, improving their education systems and putting more researchers to work at the scientific frontier. Any discoveries they make can be used in the US as easily as anywhere else. FT Video Weak US GDP – reasons to be positive

June 2014: James Mackintosh on why there are reasons to be positive about weak US GDP figures, which, he says, reflect problems with snowfall rather than fundamentals. In that case, the improvements that come from scientific discovery may be sustainable. Productivity growth need only slow to about 1.6 per cent. Add in some modest increase in population and the economy as a whole could expand at 2 per cent per year or a little more. Mr Fernald’s long-run forecast is 2.1 per cent. This suggests that the Fed open market committee’s latest projection of 2.2 per cent is not far off. Climate Corporation shows how innovative the US still is – and how computers can yet boost productivity in unexpected ways. To sustain that magical run of 2 per cent growth in output per person, however, the US may need more Silicon Valleys to emerge in China and India, and add their heft to the eternal pursuit of another bushel of corn from the same acre of land. Intel, clock speed and the measurement of productivity growth Is the recent slowdown in productivity growth nothing but a statistical mirage? A recent study by economists David Byrne, Stephen Oliner and Daniel Sichel notes a fascinating discrepancy between price and performance data for microprocessors (see chart above). This is important because the rapid progress of processing power is what drives the technology revolution. 26

Moore’s Law – the trend identified by Intel co-founder Gordon Moore that computer power doubles every two years – has continued apace. But at the same time, whereas the measured price of computing power was falling at a rate of 70 per cent a year between 1998 and 2000, the pace of decline more recently has slowed to 3 or 4 per cent. That translates into a slower pace of measured productivity growth. Mr Oliner, currently at the American Enterprise Institute, a Washington think-tank, has a few ideas about what may be happening. One is an increase in Intel’s market power. “Starting in about 2006, which is when the break occurred, Intel really solidified its market position relative to AMD,” its main competitor, he says. Less competition may mean slower price declines for its older products. In about 2006, Mr Oliner continues, “Intel itself had a major breakthrough and developed multi-core chips.” Instead of driving up “clock speed”, the most familiar way of measuring the processing speed of a chip using megahertz or gigahertz, it started including multiple copies of the basic processor within the same chip. If computing power were still measured using clock speed, however, the pace of improvement would appear to suddenly decline. The US Bureau of Labor Statistics uses a range of tools to measure computing power. One argument in favour of its data – which suggests the pace of progress in computer chips has slowed massively – is that consumers seem to be replacing their desktops less frequently. http://www.ft.com/intl/cms/s/2/c1149cda-fd39-11e3-8ca9- 00144feab7de.html#axzz36IQHvNpV

ft.com Comment Letters July 1, 2014 11:58 pm Investment in R&D is vital for productivity gains From Mr Josef Konvitz. Sir, In “US economy: The productivity puzzle”, Robin Harding made the usual inferences that China, India and other emerging economies are going to provide the US with competition and contribute the next wave of commercially relevant innovations that will reshape consumer culture and the world of work (Analysis, June 30). More IN LETTERS// Silence over the Iraq war is inexcusable/MQM parliamentarians face a daily threat in Karachi/ BIS warning over euphoric markets doesn’t make sense/ Cameron is no returning hero Europe is strangely missing from this article. The US, we know, depends on business for R&D more than any other OECD country. In the US, there were 76 researchers per 10,000 in the labour force in 1990, 90 in 2001, and 97 in 2006. These world-beating levels help explain the growth of productivity in the US that is the subject of Mr Harding’s article. But note how this increase has leveled off at the same time as the level increased dramatically in several European countries. According to OECD statistics, the number of researchers per 10,000 in the work force increased in Finland from 55 in 1990 to 156 in 2007, in Denmark from 40 to 102 and in Sweden from 58 to 106. The rate of growth in Germany was even higher, from 16 to 72 in the same period. Productivity is the major limit to growth in the UK, where levels increased from 45 in 1990 to 56 in 2007; the levels in France and Belgium are higher, at 82 and 83 respectively. The stock remained flat in Italy, however: 32 in 1990, and 36 in 2007. When economic historians look back at the Great Recession, they may well find that the investment in human capital in Europe in the two decades before the crash of 2008 helped keep its economy afloat. By contrast, the 2007 figure for China is 19 per 10,000 and for India, 2 per 10,000. We all know that convergence often translates into higher rates of growth but institutional and organisational capacities, intellectual property rights and regulatory openness and flexibility all affect outcomes. Josef Konvitz, Paris, France http://www.ft.com/intl/cms/s/0/597d744a-010b-11e4-a938- 00144feab7de.html#axzz36IQHvNpV

Money matters? Perspectives on Monetary Policy

A blog by Francesco Papadia, providing a personal perspective on monetary policy developments drawing from an experience of 40 years in critical positions in central banking.

Friday, 27 June 2014 Guessing ECB liquidity until the first Targeted Longer Term Refinancing Operation The position of money market rates in the €-area within the corridor recently set by the ECB (-10 to + 15 basis points) depends on the outstanding amount of excess liquidity demanded by banks, and is thus not under the direct control of the ECB. It is thus useful to try and guess what excess liquidity could do between now and the first Targeted Longer Term Refinancing Operation (TLTRO) in September. In principle one could follow either a bottom up or a top down approach to carry out this exercise. Under the bottom up approach, one would notice that, while the TLTROs effects on liquidity would not have come into effect as yet, the consequence on excess liquidity of the non sterilisation of Securities Market Program purchases will be there. In addition, the usual forces will be at play: drawings under "ordinary operations" (MROs - Main Refinancing Operations and LTROs - Longer Term Refinancing Operations), reimbursements of about to mature Very Long Term Refinancing Operations (VLTROs) and autonomous factors. Given the uncertainty about all these factors, I find a bottom-up estimate, assessing the individual sources or uses of liquidity in isolation and summing them up, impossible to make. It is easier to make a top down estimate: how much liquidity will banks want to hold, independently of the source? The cost of holding liquidity is critical in this respect. If you consider that this cost corresponds to the "bid-ask" of ECB funding, which is the effective width of the corridor, this has not changed as the distance between the MRO (which I take as the relevant ceiling of the corridor because of the full allotment-fixed rate auctions) and the deposit rate (the floor) has not changed. There is, however, a sense in which the cost of holding liquidity has changed and this is the negative deposit rate, which should disincentivate liquidity demand. The prospect of TLTROs should exercise, instead, a positive effect on liquidity demand from banks. Before the announcement by the ECB of its package of measures on June 5th, banks had to prepare for the risk of not being able to rollover, al least with sufficient maturity, the 2 three years VLTROs, which will expire at the turn of the year. In a way, the progressively shortening of the funding drawn under the VLTROs was having a negative effect on the demand for ECB liquidity. Now they have the prospect 29

of rolling over much of that funding through the TLTROs in September and December, which are really 2 year VLTROs, capped but without conditions, therefore they can regard the maturity of ECB funding as being, in practice, extended. The net effect of the two factors will probably be positive on the demand for liquidity obtained from the ECB. What has happened since the latest ECB move in terms of excess liquidity and EONIA can also shed some light on future developments. Chart 1. ECB excess liquidity

Source: ECB As can be seen from chart 1, the trend of ever lower excess liquidity seems to have been broken since the beginning of June: I hesitate to identify a new positively sloped trend, but I think one sees a possible break of the previous downward trend. On EONIA itself, after the ECB move this has approached zero, as in chart 2. Chart 2: EONIA developments

Source: ECB However, the OIS (Overnight Index Swap) yield curve (Chart 3) indicates that EONIA should settle around a level of 4-5 basis points for maturities between 2 months and 1 year. Chart 3: Euro OIS curve (25th of June)

Source: Bloomberg

We are talking about very small amounts, as the difference between the close to zero EONIA spot in recent days and 4 to 5 bp for OIS maturities from 2 months to 1 year is tiny and probably irrelevant. Still I think it is rather the level just above 0 that is, on average, broadly consistent with an amount of excess reserves of 100-150 billion prevailing since the ECB move, with the new effective floor of -3 bp (taking into account the theoretical floor of -10 and the "Sparkassen premium" of 6 to 8 bp) and with the prospective demand for liquidity. I am not sure, however, we can exclude that there would continue to be occurrences of the "cobweb pattern", whereby banks behaviour will introduce waves in excess liquidity demand and therefore in EONIA [1]. This can be generated by the fact that, unless liquidity is very abundant (say higher than 150 billion), when market rates are low, banks borrow from the market rather than from the ECB but, by not drawing liquidity from the central bank, banks reduce excess liquidity and this will tend to raise money market rates, but then, when market rates are high banks will again borrow more from the ECB and thus inject liquidity and thus lower rates and so on..... In conclusion, my best guess for EONIA before the first TLTRO in September is that this could hover close to zero and a little lower than implicit in the 4-5 bp of OIS curve. I am not confident enough, however, to exclude a risk of continued instability of the cobweb type, even if the probability of this is lower than before the ECB move. A level of EONIA hovering close to zero is somewhat higher than my -8 bp expectation before the ECB move [2]: this is due, first, to the fact that the ECB reduced rates by only 10 bp while I was expecting 15, and, second, to the fact that the LTRO is not as "enticing" as I thought/hoped, since it is limited and short for the first two operations and conditional for the following ones. http://moneymatters-monetarypolicy.blogspot.co.uk/2014/06/guessing-ecb-liquidity- until-first.html

Chart of the week: Political groups in the European Parliament since 1979 - Europe has been here before. Until the 1990s, the overall balance of political forces was remarkably similar to the current one by Nicolas Véron on 1st July 2014 76733 The results of the European Parliament election of May 22-25 have been described as “a shock, an earthquake” by the French Prime Minister because of unprecedented gains by anti-establishment and in some cases xenophobic parties denouncing the European status quo. The long-term trends, however, indicate a different perspective.

Much of the pan-European comment, as always, comes from the London-based international press focusing on the outcomes in the UK and, to a lesser extent, in the familiar old neighbor across the Channel. True, the shifts in Britain and France have been among the most dramatic. The UK Independence Party (UKIP) came in first, as did the National Front in France, while the governing French Socialist Party did worse than ever. But the vote in other countries suggests a more nuanced view. In Italy, the governing centre-left and pro-European Union (EU) Democratic Party won decisively. In Spain, the dominance of the two mainstream parties was eroded, but the gainers were mostly pro- EU even when they were anti-system. Conversely in other countries, key parties were pro-system from a domestic perspective, some of them even governing in their countries, but nevertheless anti- EU – for example, Hungary’s Fidesz and indeed the UK’s own Conservatives. About everywhere, and as usual in European elections, national political developments overwhelmingly influenced voters’ choices. A longer-term perspective is reflected in in the chart above, showing all European Parliament elections (one every five years) since the first one by universal suffrage in 1979. Political groups in the Parliament have occasionally changed name and composition in terms of national member parties, but there is enough continuity to observe trends.

The two main groups have always been the centre-right European People’s Party (EPP) and the centre-left Socialists & Democrats (S&D). The centrist liberals, now known as Alliance of Liberals and Democrats in Europe (ALDE), have also been present since inception, as has a group of communist and other left-of-centre parties, now called European United Left / Nordic Green Left (EUL/NGL). The Greens appeared in the 1984 election in alliance with regionalists, and have had their own group continuously since 1989. The UK Tories joined the EPP in the 1994, 1999 and 2004 but have been the core of a Conservative group both before (European Democrats) and after (European Conservatives and Reformists). Various other right-of-centre nationalist groups have come and gone. The current incarnation is the Europe of Freedom and Direct Democracy (EFDD) party, which includes UKIP and Italy’s Five-Star Movement. There was also a separate regionalist group following the 1989 election, and a split centrist group following the one in 1994. Finally, each parliament has a number of independents, currently at record level since France’s National Front failed to join or constitute a group. The chart shows the shares of total Members of the European Parliament (MEPs) for different political groupings on the basis of this typology. Given the EU system’s significant deviation from the principle of electoral equality, this breakdown may be somewhat different from the EU-wide popular vote. Also, the absolute number of MEPs has almost doubled because of successive EU enlargements, from 410 in 1979 to 751 today. One obvious fact springs from the graph: Europe has been there before. Until the 1990s, the overall balance of political forces in the European Parliament was remarkably similar to the current one, even though its national components have changed somewhat. Compared with the heyday of the “European mainstream” in the 1999, 2004 and 2009 elections, the earlier period saw stronger parties both on the left and on the right of the centrist block of EPP, ALDE, S&D and Greens (who may be radical on certain policies but are here included in the “European mainstream” in terms of their stance on EU integration). Strikingly, the legislatures that followed the 1984 and 1989 elections were the ones when Jacques Delors was President of the Commission, an era often seen in Brussels as the halcyon days of European integration. A key question for the future, of course, is whether the recent trend will continue, and whether the “anti” parties may increase their gains further in the next election, scheduled in 2019. While an extrapolation of the chart may suggest such a prospect, it is far from inevitable. An optimistic reading of the appointment of EPP lead candidate Jean-Claude Juncker, the former prime minister of Luxembourg, as Commission President (which remains to be confirmed by a vote of the European Parliament itself) suggests that the next election may differ markedly from previous ones, including this year’s. Given the Juncker precedent, EU member states’ citizens may be motivated to elect a specific party with a positive outcome in mind (their preferred pick for the top job) as opposed to a protest vote. If confirmed, this could trigger another trend reversal. | Read more at Bruegel: http://www.bruegel.org/nc/blog/detail/article/1376-chart-of-the-week-political-groups-in-the- european-parliament-since- 1979/?utm_source=Bruegel+Chart+of+the+Week&utm_campaign=4050c78ff3- Bruegel+FotW_Week_27_2014&utm_medium=email&utm_term=0_c8cb239d3a-4050c78ff3- 277606509

Ricardo Hausmann Ricardo Hausmann, a former minister of planning of Venezuela and former Chief Economist of the Inter-American Development Bank, is a professor of economics at Harvard University, where he is also Director of the Center for International Development. JUN 28, 2014 3 The Open Drains of Latin America NEW YORK – Stories are most believable when they reaffirm our prior beliefs and assumptions. If not, we tend to find them implausible. A case in point is Eduardo Galeano’s much-admired 1971 book The Open Veins of Latin America, which has sold more than one million copies in 12 languages and defined a generation’s view of the region’s tortured history. The late Hugo Chávez gave US President Barack Obama a copy when they met in 2009 in Trinidad. The book is commendable for its ability to describe five centuries of Latin American history with great coherence, something that only a work of fiction can achieve. History, unfortunately, is a bit more complex. A few weeks ago, Galeano, to the astonishment of many, distanced himself from his own book. He said he could no longer bear reading it, and that when he wrote it, he “lacked sufficient knowledge of economics and politics.” Why was the book so well received, and what accounts for its author’s second thoughts? Galeano’s book interprets Latin America’s history as the consequence of foreign plunder. Over the centuries, bad guys change nationality – say, from Spanish to American – but their intentions remain the same. Current problems are the result of evil deeds committed by foreign powers that came only to exploit. The poor are poor because they are victims of the powerful. Even the most distorted myths contain a kernel of truth. Throughout human history, those with superior technology have tended to displace or even annihilate their neighbors. That is why the Welsh and the Pygmies live in remote places, and why English, Spanish, and Portuguese are spoken in the Americas. In fact, recent scientific evidence indicates that the Neolithic Revolution – the transition from hunting and gathering to agriculture – spread mostly because farmers displaced hunters, not because hunters learned from them. But, while technological superiority and confrontation can wipe out the weak side, technological diffusion across cultures can be mutually beneficial. It allows all to do more with less, thereby generating a surplus that can be distributed. As in any such relationship, all parties want to get the lion’s share of the gain, but some get the short end of the stick. Yet, without the relationship, there would be no stick. The real challenge for a patriot is to obtain the largest amount of pie, not a large share of a small pie.

Alas, those inspired by Open Veins, like Chávez (and Fidel Castro before him), are bound to create very small pies. For example, while Chávez’s intention was to double Venezuela’s oil production to six million barrels per day by 2012 – a feasible goal, given that the country has the world’s largest oil reserves – his penchant for expropriation and for firing able dissenters caused output to fall by one-fifth. While Venezuela remains mired in economic malaise, its allies – China, Russia, Brazil, and OPEC – have raised output by 14 million barrels per day, laughing all the way to the bank. But to tell the story of Latin America as one of foreign pillage is to ignore the benefits that the region has gained from foreign efforts, especially in Venezuela. So here is an alternative story. Once upon a time, in ancient Mesopotamia, oil was known to exist and it was peddled by some quacks for its medicinal powers. Around 1870, John D. Rockefeller spearheaded the development of the modern oil industry to produce kerosene for lighting. Later, while he was in a ferocious confrontation with Thomas Edison, who was threatening Rockefeller’s business with the electric bulb, unrelated technological developments led to the gasoline-powered internal combustion engine and to the idea of putting it on wheels. This soon made oil the preferred energy source for transportation, not lighting, and even for electricity generation. But to develop the oil industry, many more technological advances needed to occur. First, oil had to be found. Then it had to be extracted, refined into more useful products, and transported cheaply. All of that required a plethora of breakthroughs in geology, metallurgy, material science, chemical engineering, cars, roads, cities, rules, and other areas. It was this extraordinary technological revolution that made oil valuable. While this was happening, many of today’s large oil producers – including Venezuela, Saudi Arabia, Iran, and Nigeria – were missing in action. For the most part, they did not know that they had oil or where it was. They did not know how to get it out. They did not know about seismic lines, drilling, pipelines, refineries, or tankers. More important, they did not do much to construct the complex ecosystem that makes oil valuable. They did, however, have the right to restrict access to their underground resources in order to extract rents, just as the despised agricultural landowners have done for centuries. They could become rentiers and live off the work and ingenuity of others. The chutzpah of Open Veins and Chávez is to describe their situation as victimhood, not good fortune. Similar stories can be told of other industries, even those that do not require natural resources but rely on global value chains instead. In developing countries, economic progress requires absorbing and adapting technology that exists in other places, which necessitates engaging with those that have it. By characterizing these interactions as pure exploitation, rather than as value-creating opportunities, the Open Veins mentality has been a real drain on the possibilities of so many in Latin America and elsewhere.

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Business & Finance

Koichi Hamada Koichi Hamada, Special Economic Adviser to Japanese Prime Minister Shinzo Abe, is Professor of Economics at Yale University and Professor Emeritus of Economics at the University of Tokyo. JUN 30, 2014 Abe’s Bullseye TOKYO – Japanese Prime Minister Shinzo Abe has unveiled his long-awaited growth strategy – the so-called “third arrow”of what has come to be known as “Abenomics.” A preliminary version of the plan, announced to Japan’s Diet last year, was met with disappointment in international financial markets, which had expected a bolder approach. The new version is far more robust – and has received a far more positive global response. Over the last 18 months, the first and second arrows of Abenomics – consisting of expansionary monetary and fiscal policies – have achieved considerable success in spurring Japan’s economic renewal. For starters, they have fueled price growth, with the GDP price deflator declining from 3% to nearly zero. Moreover, the ratio of job openings to applicants, which fell to 0.4 under Japan’s last government, led by the Democratic Party of Japan, is now approaching 1.1. Indeed, Japan is beginning to show signs of a labor shortage. But the limits of Abenomics’ first two arrows will soon be reached. With employment rising as Japan’s economy moves toward realizing potential output, monetary stimulus will create inflationary pressures and public expenditure will yield sharply diminishing returns. At that point, significant growth can be achieved only by increasing the economy’s real productive capacity. That is what Abe’s new growth strategy aims to achieve. At the strategy’s core is the removal of obstacles to growth for businesses, particularly the elimination or easing of regulatory barriers. Deregulation promises to bolster the ability of Japan’s private sector, which already excels in high-technology industries, to innovate and compete globally. While some officials, who may benefit from business regulations, may resist this initiative, its economic benefits, together with Abe’s determination, are compelling. At the same time, Japan will undergo sweeping labor-market reforms, open designated industries to foreign workers, and create “special economic zones” within which

officials will have the authority that they need to reduce red tape in areas like agricultural land management. If concluded, the Trans-Pacific Partnership – a mega- regional 12-country free-trade agreement – will provide an additional boost to Japan’s economy. Perhaps the most promising reform is corporate-tax reduction, which will help Japan boost both foreign and domestic investment. By spurring increased business activity, it will actually increase Japan’s corporate-tax revenue. By global standards, Japan’s current corporate-tax rate of 35% is quite high. Indeed, while it remains lower than in some US states (California’s rate, for example, stands at 40%), it exceeds the rates applied in Germany (25%), China (24%), South Korea (24%), the United Kingdom (24%), and Singapore (17%). A quarter-century ago, the UK and Germany had higher corporate-tax rates than Japan. But they have since recognized the value of reduced rates. The UK practically waged a tax war against other countries to attract investment. Both countries’ experiences have demonstrated that substantial reductions over a short period are far more effective than a gradual, drawn-out process. Fortunately, Abe plans to follow suit. The impact of this approach may be even more pronounced in Japan, where only a small share of firms currently pay corporate tax. One reason for this is the contractionary monetary policy pursued by former Bank of Japan Governor Masaaki Shirakawa, which prevented the economy from reaching its growth potential for more than 15 years, until Haruhiko Kuroda took over the position. Japan’s so-called “special measures for corporate tax” – ad hoc provisions that reduce or waive certain taxes for firms at particular times – have also contributed to sustaining the economy’s output gap. These measures not only distort resource allocation; they also often lead to collusion between businesses and government officials seeking opportunities to enter the private sector upon retirement. Eliminating them would go a long way toward increasing corporate-tax revenue, without stifling growth. Abe’s growth strategy has the potential to bring massive benefits to Japan. But it will also demand sacrifices. Consumption-tax hikes will be borne by consumers; the TPP will create new challenges for farmers; and deregulation will run counter to some bureaucrats’ interests. In this context, it is reasonable to expect businesses to relinquish some of their tax exemptions. The Abe government has presented a set of forward-looking reforms – and appears determined to follow through on implementing them, even if doing so means confronting those with a vested interest in their failure. If the third arrow succeeds in sustaining Japan’s economic revival, there will no longer be any room to doubt the merits of Abenomics. http://www.project-syndicate.org/commentary/koichi-hamada-praises-the--third-arrow-- of-the-japanese-government-s-growth-strategy

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World Affairs

Howard Davies Howard Davies, a professor at Sciences Po in Paris, was the first chairman of the United Kingdom’s Financial Services Authority (1997-2003). He was Director of the London School of Economics (2003-11) and served as Deputy Governor of the Bank of England and Director-General of the Confederation of British Industry. JUN 27, 2014 Looking Beyond Juncker The European Union appears to be capable of concentrating on only one problem at a time. This summer it is the question of who will succeed José-Manuel Barroso as President of the European Commission. British Prime Minister David Cameron has found himself fighting a rearguard action to try to block the appointment of the arch- federalist Luxembourger Jean-Claude Juncker. The Commission presidency is no doubt an important job. The Commission retains a monopoly on proposing new legislation, the character of which is heavily influenced by the president. But new legislation is something of a luxury for Europe these days. Rather than contemplating exciting new directives on the desirable characteristics of, say, lawnmowers sold in the EU, Europe’s leaders must complete three urgent and interlinked tasks. The first is political. In the recent European Parliament election, a quarter of voters in the United Kingdom and France backed parties that are hostile to further integration and committed to restoring a Europe of independent member states. Even in Germany, a euroskeptic party did surprisingly well. The center-left and center-right federalists have responded by making common cause to secure a majority for Juncker. That is not a stable outcome. Defenders of the European ideal need to engage more directly with its critics and articulate an inspiring vision, rather than sticking their heads in the sand and intoning the words “ever closer union” at every opportunity. They would find it easier to win over euroskeptics if they could point to more solid and durable economic achievements. Eurozone growth remains sluggish, at 0.7% over the last year, while unemployment, at 11.7%, is unacceptably high. These averages are depressing enough, but some parts of the continent are in far worse shape. Spanish unemployment is above 25%, and the Italian economy has barely grown since the euro’s introduction. Economic recovery is being held back by financial problems – the third hot topic that EU leaders must address. The single financial market broke down four years ago and has not yet been repaired. To be sure, the European Central Bank has done what it takes to narrow the borrowing cost differences between European sovereigns. For much of 2012 and 2013, the Spanish 38

and Italian governments were paying 5.5-7% for ten-year money, while the German rate was below 2%. Today, the differential is much lower. Spain and Italy are paying only around 150 basis points more than Germany. ECB President Mario Draghi can take credit for that. But from businesses’ perspective, things look rather different. For a Spanish or Italian small firm, the interest-rate differential remains as high as it was. An unsecured business loan will cost a Southern European firm two percentage points more than its counterpart on the Rhine, even though the two companies have a similar credit rating. Until 2010, the gap was just a few basis points. It exploded in 2011 and has not narrowed since. That is a serious competitive disadvantage to add to the penalty of being at a greater distance from the EU’s center of economic gravity. If it persists, it will reinforce the growing division of Europe into “haves” and “have-nots.” How can such a differential persist in what is supposed to be a single, integrated financial market? The answer, of course, is that the eurozone is no such thing, at least not yet. The crisis of confidence in the EU banking sector that erupted in 2010 has not yet been resolved. European banks are still reluctant to lend to one another, especially across borders. They suspect that some of their counterparts are weak and vulnerable, and have little confidence in the willingness of national bank supervisors to reveal the truth and demand remediation. So German banks with surplus cash would rather deposit it at the ECB than put it to work in Italy or Greece. The banking union was agreed in order to correct that problem, with the ECB front and center as the single supervisor of all major European banks. But the market is clearly signaling that the banking union has not yet done its job – indeed, that it is by no means complete. There are doubts about the lack of a unified deposit-protection scheme, about the availability of funds to resolve a failing institution, and about whether the ECB’s approach will be rigorous enough to identify the lame ducks, force them to recapitalize, and thus rebuild confidence. The key test will come this autumn, when the ECB reveals the results of its asset quality review. I expect the supervisors to be rigorous: their institution’s credibility depends on it. But national supervisors and governments retain a significant role. Will they be prepared to be honest and, more important, willing and able to help the walking wounded raise capital? Recent debt issues by the Italian bank Monte dei Paschi di Siena and others have shown that financing for banks is expensive. Investors need to be offered heavy discounts to persuade them to part with their money. As a result, some banks that suspect that their balance sheets will be revealed to be weaker than they have so far acknowledged are cutting back on lending. The continuing credit constraints are one reason that parts of the European economy remain weak. So the three problems that Europe will face in the second half of this year are closely connected. The EU will need the strongest leadership team that it can find to steer through treacherous waters and implement crucial financial reforms. Just now, the signs are far from promising. There are few new faces or ideas on the horizon. We must hope to be surprised.// http://www.project-syndicate.org/commentary/howard-davies-identifies-three- urgent-and-interlinked-tasks-that-european-leaders-need-to-complete

World Affairs

J. Bradford DeLong// Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau of Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates. JUN 30, 2014 The World’s Central Banker BERKELEY – The US Federal Reserve these days is broadly happy with its monetary policy. But, since mid-2007, its policy has been insufficiently expansionary. The policy most likely to succeed right now would be analogous to that implemented by the Fed in 1979 and 1933, Great Britain in 1931, and Shinzo Abe today. Those of us who fear that the Fed’s approach has greatly deepened the US economy’s malaise and is turning America’s cyclical unemployment into permanent long-term structural non-employment have lost the domestic monetary-policy argument. But there is another policy argument that needs to be joined. The Fed is not just the US central bank; it is the world’s central bank. America’s current exchange-rate regime is one of floating rates – or at least of rates that can float. Back in the 1950s and 1960s, economists like Milton Friedman assumed that a global regime of floating exchange rates would be one in which currency values moved slowly and gradually alongside differences in the economy’s inflation and productivity-growth rates. In the 1970s, the economist Rudi Dornbusch (and reality) taught us that that was wrong: a floating-rate regime capitalizes expected future differences in nominal interest rates minus inflation rates into today’s exchange rate. A country that changes its monetary policy vis-à-vis the US changes its current exchange rate by a lot; and, in today’s highly globalized world, that means that it deranges its import and export sectors substantially. Because no government wants to do that, nearly all governments today follow the US in setting monetary policy, diverging from it only tentatively and cautiously. So the US is not just one economy in a world of economies following their own monetary policies under a flexible exchange-rate regime. The US is, rather, a global hegemon: the central bank for the world, with a responsibility not just to stabilize output, employment, and inflation and ensure financial stability in the US, but also to manage the world economy in its entirety. One area of concern is the health and stability of growth in emerging markets as they attempt to benefit from capital inflows; satisfy North Atlantic demands for open 40

financial markets; and manage the resulting instability created by speculative “hot money,” the carry trade, irrational exuberance, and overshooting. Emerging-market central-bank governors fear a US that alternates between expansionary policy that fuels huge hot-money inflows and a domestic inflationary spiral, and rapid tightening that chokes off credit and causes a domestic recession. Then there is the main problem facing the global economy today: the crisis of Europe and the eurozone. The creation of the euro without an appropriate fiscal union meant that transfers from surplus to deficit regions would not eliminate or even cushion demand imbalances. The fact that the eurozone lacked the labor-market flexibility needed to make it an optimal currency area meant that adjustment via regional reallocation of economic activity would be glacial, while its members’ loss of control over monetary policy ruled out adjustment via nominal depreciation. Moreover, Europe lacks the governance institutions needed to choose the easiest path to manage economic rebalancing: moderate inflation in the north, rather than grinding deflation and universal bankruptcy in the south. The European Union’s institutional design amplifies the voices of those interests pushing for policies that have now set Europe on the deflationary road, thus all but guaranteeing lost decades during which the EU will fail to deliver growth and prosperity. We have an example from the early twentieth century of the political consequences of such a period of economic depression and stagnation. The reaction to what Karl Marx called “parliamentary cretinism” is the rise of movements that seek, instead, a decisive leader – someone to tell people what to do. Such leaders soon learn that their solutions are no better than anybody else’s and decide that the best way to remain in power is by blaming all problems on foreigners. Thus they exalt the “nation” and focus their policies on zero-sum quarrels with other countries and on scapegoating deviant “aliens” at home. This is not in Europe’s interest, and it is not in America’s interest to have to deal with such a Europe. A democratic, prosperous, and stable Europe implies a much better and safer world for the US. Here is where the Fed comes in. By shifting its monetary-policy regime to target 4% annual inflation – or 6% annual nominal GDP growth – the US would set in motion rapid rebalancing in the eurozone. Rather than see the 30% euro appreciation that would follow from the ECB’s current monetary policy, German exporters would scream for measures to prevent America’s “competitive devaluation,” finally bringing about moderate inflation in the north rather than the current grinding depression in the south. A world in which the US has a proven record of honoring the trust that is required of it to play the role of global economic hegemon is a much better world for the US than one in which it is not trusted. Simply put, the US must manage the global economy for the collective common good, or else confront a world in which global macroeconomic management results from race-to-the-bottom national policy struggles. America’s medium- and long-term political, security, and, yes, economic interests require the Fed to recognize that its policy mission is not to focus narrowly on attempting to achieve and maintain internal balance. Rather, it is to embrace and fulfill its role as the world’s central bank, by balancing aggregate demand and potential supply for the global economy as a whole./ http://www.project-syndicate.org/commentary/j--bradford- delong-argues-that-the-us-will-face-a-dangerous-world-unless-the-federal-reserve-fulfills-its-global-role

Daily Morning Newsbriefing June 30, 2014 Italy says deal on fiscal rules will allow €10bn in extra spending The media have been, of course, preoccupied with Britain and Jean-Claude Juncker. The substantively most important decision taken at the summit was a reorientation of the stability rules – not a formal change, but a firm guidance to the European Commission to allow the maximum use of flexibility within the existing rules. Here is what the final conclusions say (emphasis ours, omission include the usual lip service to structural reforms): “The possibilities offered by the EU's existing fiscal framework to balance fiscal discipline with the need to support growth should be used…while making best use of the flexibility that is built into the existing Stability and Growth Pact rules.“ For Italy, this effectively adds another €10bn, some 0.5% of GDP, in additional fiscal flexibility, according to Graziano Delria, Renzi’s minister of state and right hand man. Corriere della Sera leads the paper this morning with an interview with Delria, in which he says the agreement to relax co-financing rule would produce another €7bn in investments, while another €3bn would come from a clause that would exempt certain type of investments from the Maastricht deficit calculations. He said it was, of course, up to the Commission to define the room for manoeuvre. He also made the ominous statement that debt-to-GDP will fall “in a different manner”. Over at Frankfurter Allgemeine, Werner Mussler concludes that the reason Angela Merkel agreed to this interpretation is that the stability pact no longer has a political priority for her. He writes the 2005 rules are extremely flexible. That flexibility will now be used to the fullest He notes that Merkel has never left an area of political importance to her to the European Commission. The fact that she now would suggest that she is setting up the Commission for future infringements of the rules. The European Council also agreed a Strategic Agenda for the EU over the next five years, pledging to bring the EU2020 strategy in line with the listed priorities in the agenda. The most concrete pledge we could detect were the completion of the digital single market by 2015, and the will to proceed with the integration of energy markets whilst juggling three goals: render energy cheaper, more secure and greener. On Juncker there were tons of articles everywhere. We noted an interesting report from Le Monde. After supporting Juncker, the Social Democratic leaders now claim in exchange the presidency of the European Council. Several leaders of the euro zone including François Hollande also refuse to entrust this job to someone from outside the eurozone, such as the Danish Social Democrat Helle Thorning-Schmidt, who is appreciated by David Cameron.

Simon Nixon makes a good point in the Wall Street on the nomination of Juncker. It was not just about Britain vs the rest, but also about the north vs. south: Potentially far more damaging were the splits between the euro-zone core and periphery, between big states and small states, between the rich north and poorer south and an institutional split between the European Parliament and the European Council which comprises EU leaders.Mr. Juncker was chosen because it was simply too hard to choose anyone else. Opting for the non-confrontational, non-ideological, consensus- building veteran Brussels deal-maker allowed these other rifts to be swept under the carpet.” Why the Commission needs to prioritise investments Now that Juncker has been nominated, attention is focusing on what he needs to do. In his FT column Wolfgang Munchau notes that Juncker’s most important job will be to raise investment. He says it will be extraordinarily difficult given the scale of the decline in investment. A relaxation of how investments are treated in national accounts, and a shift in co-funding rules will have some effect. But there is a huge need for EU- level investment. Juncker will have to find a way to fund it – ideally as Munchau writes through some monetised form of Eurobond financing, which would simultaneously help raise investments and raise inflation rates – a fortuitous combination. But even if Juncker does not go as far, he will need to find a way to raise finance to fund investments. The German research institute DIW proposes for the EU to issue investment bonds to finance a European growth agenda. The DIW’s solution is a five-year special investment plan overseen by the European Investment Fund, part of the European Investment Bank. Its proposal would see the fund raising its own capital by issuing bonds guaranteed by EU member states. Their backing would guarantee low interest rates from investors, a financial benefit which could be passed on to borrowers, according to the Irish Times. BIS and EBA warn of financial stability risks There are two reports out this morning, warning about financial stability risks. In its latest annual report, the Bank for International found it “hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally”. It has a chapter on the relationship between monetary policy and the search for yield, in which it tries to prove that monetary policy has affected risk premia and funding terms. Frankfurter Allgemeine quoted Hyun Song Shin, the BIS chief economist, as saying that everything was still looking calm, but there were signs of a “possibly painful and very destructive reversal”. The BIS is deeply sceptical about QE and other non-standard monetary policies, sees no risk of deflation, and is concerned about a delayed normalisation of monetary policy The EBA meanwhile, has a report on the EU banking sector, and in almost complete agreement with the BIS, find that “a dislocation between financial markets and the real economy”, and expresses concern about the eurozone ongoing balance sheet recession and the impact on the banking sector. It noted that banks with a RoE of less than 4% represented 39% of total assets, and when combined with the growth outlook and further deleveraging, this poses substantial stability risks. German inflation rises to 1% in June 43

This is potentially good news for the ECB – but it is not yet conclusive evidence of a recovery in prices. The HICP measure of German inflation rose to 1% in June, after 0.5% in May. The breakdown of the data – which applies only to Germany’s own, and different measures, show an annual increases in services prices by 1.6%, in rents by 1.5%, counterbalanced by a fall in energy prices of 0.3%, 0% for food, and 0.3% for manufactured goods. The rise in the German inflation index will boost the eurozone index for June by the sheer size of Germany’s weight – although probably not to the same extent. Spain to nominate Román Escolano to the EIB El País reports that the Spanish government, with the agreement of Portugal, will nominate Román Escolano to replace Magdalena Álvarez as EIB vice-president. Escolano, an economist and career civil servant, currently heads Spain’s public credit institution ICO. Politically, Escolano is close to former Spanish PM José María Aznar, in whose cabinet he was chief economic advisor in 2000-2004. Spanish grass-roots movements organize to contest next Spring’s local elections After the success of Podemos in the European elections, Spain’s grass-roots movements are setting their sights on the municipal elections to be held in the Spring of 2015. The process is most advanced in Barcelona where a citizens’ platform called Guanyem (“let’s win”) was presented last Thursday. Over the weekend El Diario interviewed Ada Colau, who is one of the representatives of Guanyem after stepping down as the spokesperson of the PAH “association of mortgage victims”, which gave her national prominence. Following on the example of Guanyem, over the weekend there was a meeting called Municipalia to explore the possibility of a citizens’ front to contest the Madrid local government, reports Diagonal. Greek economic sentiment breaks through 100-mark The EC Economic sentiment indicator for Greece improved further by 4.6 points in June to reach 103.7, surpassing the 100- point mark for the first time since August 2008, Macropolis reports. EC data also showed an improvement of consumer confidence for the fourth consecutive month. The headline figure rose by 2.7 points in June to -49.8 reaching its highest level since February 2010. French and Portuguese fiscal deficits rising Insee reported the French deficit in the first quarter this year to worsen to 4.4% of GDP compared with 4.2% in the previous quarter. Though the statistical institute cautioned against deducing any conclusions for the annual figures it is clear that these figures will

increase pressure on the government. Its target of reducing the deficit to 3.8% of GDP this year already questioned by the Court of Auditors and economists. On the expenditure side the "tax credit for competitiveness and employment" (Cice), a subsidy to companies, showed its impact with spending accelerating by 1% compared with 0.6% in the last quarter. Revenues increased 0.7%, with the kick in of the VAT rise since January, accelerating VAT revenues by 2.7%. Portugal's budget deficit in the first quarter of the year reached 6% of GDP, down from 10% in the same quarter of 2013, but above the 4% target agreed with international institutions by the end of the year, Jornal de Negocios reports. This value is more negative than the government's agreed target and compared to what had been estimated by the Technical Unit for Budgetary Support (UTAO), albeit with a relatively wide range of 4.9% to 6.3%. In its May report UTAO also noted that in the last two years, the deficit for the first quarter exceeded the value for the entire year. No place for poor countries Simon Tilford makes the argument that the eurozone is no place for poor countries, and that economically weak member states should think twice before joining. He writes the economic rationale for poorer countries joining the eurozone was it would hasten convergence. He looks at the data, and showed that this did not happen, except in Spain, but there too that trend is reversing. “Reducing these leverage ratios will be hard. Firms and households will continue to pay down debt for a long time to come, depressing consumption and investment. For their part, poorer eurozone governments risk contributing to the weakness of demand by continuing their drive to consolidate public finances. The result threatens to be weak economic growth and inflation and hence slow deleveraging. This is less a cyclical issue than a semi-permanent state of affairs. Growth in the poorer states will at some point in the future exceed that of the wealthier North, but any convergence is likely to be slow because of the permanent damage done to their growth potential.” Bank run on two Bulgarian banks Not exactly inside our reservation, but a bank run in an EU member state is an issue we are not going to ignore. Bulgaria had to face down a bank run last week on two of its banks, CorpBank and First Investment Bank. Bulgaria's central bank said Friday the local banking system is being attacked through "rumors and malicious public statements" in an attempt to destabilize the country, Wall Street Journal reports. It started with negative reports in local media on alleged tensions between local business moguls holding equity states in Corpbank. Customers of First Investment bank received emails and text messages urging them to withdraw their money. Analysts say there is no structural problem in Bulgara's banking sector. A significant part of the banking sector is foreign owned, and there is the expectation is that they will put money into the Bulgarian subsidiaries if necessary. The central bank stopped operations of CorpBank after the bank ran out of cash and put it under its administration. Five men have been arrested over the weekend, suspected of "systematic efforts" to attack banks and thus destabilize the country, according to the Volkskrant. Eurozone Financial Data 10y spreads

Previous Yesterday This

day Morning France 0.334 0.342 0.348 Italy 1.486 1.481 1.480 Spain 1.401 1.386 1.404 Portugal 2.263 2.336 2.434 Greece 4.624 4.683 -1.26 Ireland 1.096 1.088 1.107 Belgium 0.450 0.455 0.467 Bund Yield 1.246 1.26 1.261 exchange rates This Previous morning Dollar 1.362 1.3644

Yen 138.020 138.25

Pound 0.800 0.8012

Swiss Franc 1.216 1.2156

ZC Inflation Swaps previous last close

1 yr 0.74 0.74

2 yr 0.85 0.85

5 yr 1.22 1.22

10 yr 1.65 1.65

Eonia

27-Jun-14 0.03

26-Jun-14 0.04

25-Jun-14 0.04

24-Jun-14 0.04

OIS yield curve 1W 0.025 15M 0.051 2W 0.040 18M 0.055 3W 0.050 21M 0.065 1M 0.054 2Y 0.090 2M 0.060 3Y 0.156 3M 0.064 4Y 0.251 4M 0.056 5Y 0.400 5M 0.062 6Y 0.558 6M 0.056 7Y 0.719 7M 0.057 8Y 0.880 8M 0.056 9Y 1.026 9M 0.071 10Y 1.160

10M 0.048 15Y 1.653 11M 0.061 20Y 1.877 1Y 0.049 30Y 1.973

Euribor-OIS Spread previous last close

1 Week 2.071 1.571

1 Month 3.714 3.214

3 Months 10.829 9.429

1 Year 37.029 37.029

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-06- 30.html?cHash=ee373c9d4ae03992e100a3f23ac0f6a4

The eurozone is no place for poor countries Written by Simon Tilford, 27 June 2014 The economic rationale for poorer countries joining the eurozone was that it would hasten economic convergence between themselves and the richer members of the currency union. They would benefit from a stable macroeconomic environment and more trade and inward investment. And Portugal aside, there was some convergence in the early years of the single currency. But this went into reverse in 2008 and by 2013 the poorer members of the currency union were no better off relative to the EU-15 average than they had been in 1999. Worse still, they have been overtaken by a number of the 2004’s EU intake, who in 1999 had been much poorer. Has the euro become a mechanism for divergence? If so, what are the implications for growth across the eurozone as a whole and for the case for joining? In 1999, Greek and Portuguese per capita GDP were around 70 per cent of the EU-15 average, and Spanish a little over 80 per cent. By 2013, Greek and Portuguese GDP was under 70 per cent of the average. Spain has not done quite as badly, but has been diverging since 2008 (see chart 1). Indeed, far from converging with the richer members of the EU, they have converged with the Central and Eastern European countries which joined the EU in 2004. In 1999, the GDP levels in Poland and Slovakia (a euro member since 2009) were 42 per cent and 43 per cent of the EU-15 average respectively. The Czech Republic’s was just over 60 per cent of the average. By 2013, these figures were 65 per cent, 72 per cent and 75 per cent. 47

For crude supply-siders, the lack of convergence between members of the eurozone reflects the failure of the poorer member-states to push through reforms of their economies rather than anything to do with the structure of the currency union. This has cost them competitiveness, leading to economic stagnation. Others maintain that divergence since 2008 is cyclical and will be quickly reversed. According to this view, the South is simply going through what Germany went through in the early 2000s. Interest rates are too high for the periphery in much the same way as they were for Germany between 1999 and 2006; conversely, they are now too low for Germany. Germany will grow more rapidly than the south for the next few years, but that will then reverse as Germany loses competitiveness and finds itself in similar position to that of the periphery now – with an overvalued real exchange rate and excessively tight monetary policy. At that point there will be renewed convergence between rich and poor. The worst that can be said is that the eurozone has amplified business cycles, but not that it has become an obstacle to convergence between rich and poor. Chart 1: GDP per capita// (EU15=100)

Source: European Commission There are problems with both these arguments. First, it is hard to ascertain a correlation between the kinds of structural reforms the Commission is demanding of the South (principally labour market deregulation) and economic growth. Some of the best performing European economies over the last 20 years – notably Sweden and Austria – have relatively highly regulated labour markets. Germany – the benchmark for much of the Commission’s thinking – also has a tightly regulated labour market (notwithstanding 2004’s Hartz IV reforms), at least in regards to permanent workers (see chart 2). There is certainly a case for labour market reforms to address insider/outsider problems and to help young people and those with poor skills into work. But it is important not to exaggerate the economic effects of such reforms. Nor can differences in product market regulation explain the lack of convergence in living standards within the eurozone. First, according to the Organisation for Economic Co-operation and Development (OECD), there has been steady convergence of such regulation among EU member-states. Second, there is no discernible correlation between levels of product market liberalisation and economic growth. For example, Sweden has among the more tightly regulated product markets in the EU, while Germany and Italy score about the same as each other. Greece does rank badly, but only as badly as Sweden did five year earlier (see chart 3). 48

This is not to say that – all other things being equal – competitive product markets will not boost economic performance, only that they can be more than offset by other things such as the wrong macroeconomic policies or misalignments of real exchange rates. The latter can have a big impact on levels of capital stock per employee and labour skills, which are more important in determining economic performance than levels of labour and product regulation. Cuts in education spending, large-scale emigration of young skilled workers and huge falls in business investment have damaged the productive capacity of the eurozone’s poorer economies. Chart 2: OECD indicators of employment protection legislation, 2013 (0 = least restrictions, 6 = most restrictions)

Source: OCED

Chart 3: OECD indicators of product market regulation // (0 = least restrictions, 6 = most restrictions)

Source: OECD The cyclical argument for the lack of convergence is also weak. There are several differences between Germany’s position in the early years of the euro and the south now. Germany’s period of retrenchment within the euro was essentially over by 2006. Germany’s real effective exchange rate was not seriously overvalued to start with. Germany was aided in its drive to reduce its real exchange rate by inflation being relatively high elsewhere in the eurozone. And, finally, the country was not highly indebted. By contrast, the retrenchment in the poorer members of the eurozone has already lasted longer than in Germany in the early 2000s, and there is no end in sight for a number of 49

reasons. First, their loss of trade competitiveness relative to the core is far bigger. Second, they are trying to regain competitiveness by holding inflation rates below the eurozone average at a time when inflation is chronically low elsewhere in the eurozone (German inflation is around 1 per cent and forecast to remain low). And third, they have very high levels of debt. Their drive to improve competitiveness is pushing them into deflation, increasing the real value of their debts and making it harder to deleverage. As a result, overall levels of indebtedness in Greece, Portugal and Spain are still close to their all-time highs. Their levels of private sector debt have fallen, but there has been an offsetting increase in public debt. According to Standard and Poor’s, the so-called leverage ratio (public and private debt as a share of GDP) in Greece, Spain, and Portugal is currently around twice what it was at the beginning of 1999; Italy’s is 35 per cent higher. Reducing these leverage ratios will be hard. Firms and households will continue to pay down debt for a long time to come, depressing consumption and investment. For their part, poorer eurozone governments risk contributing to the weakness of demand by continuing their drive to consolidate public finances. The result threatens to be weak economic growth and inflation and hence slow deleveraging. This is less a cyclical issue than a semi-permanent state of affairs. Growth in the poorer states will at some point in the future exceed that of the wealthier North, but any convergence is likely to be slow because of the permanent damage done to their growth potential. A combination of debt write-offs, co-ordinated eurozone fiscal stimulus and a concerted drive by the European Central Bank (ECB) to drive up eurozone inflation could head off this unfavourable outcome. Anything is possible, of course, but all of these things look unlikely. Low borrowing costs have reduced pressure for institutional reforms of the eurozone, even if low bond yields should be ringing alarm bells (reflecting as they do mounting deflationary pressures). The eurozone might agree an investment programme, but a big fiscal stimulus is impossible without rewriting the rules. And there is little chance the ECB is going to morph into a European version of the US Federal Reserve and launch a full-blooded battle against deflation. The fate of poorer EU-15 members of the eurozone should give prospective eastern and south-eastern EU member-states pause for thought before joining. They should also closely monitor the experience of Slovenia and Slovakia, which joined the single currency in 2007 and 2009 respectively. Slovenia is considerably poorer relative to the EU-15 average than when it joined. Slovakia has performed respectably within the single currency, but its real effective exchange rate has risen steeply relative to its peers (Czech Republic and Poland) and it has slipped into deflation. For some – Lithuania, for example – joining the euro is about guarding its independence against a revanchist Russia. But the others face a trade-off: join the euro and get a seat at the top table (more and more of the real decisions on economic issues are taken by eurozone countries rather than the EU) in return for a loss of policy autonomy and much increased economic risk. Or reiterate their commitment to join but postpone doing so in the hope that the eurozone is reformed in such a way that it becomes a mechanism for convergence rather than divergence. This is the strategy being successfully pursued by Poland and the Czech Republic. Others would be wise to follow suit.// Simon Tilford is deputy director at the Centre for European Reform./ - See more at: http://www.cer.org.uk/insights/eurozone-no-place-poor- countries#sthash.NW9dBZVg.dpuf 50

Fact of the week: Only 8% of banks says they will need to raise capital after AQR - the ECB’s Asset Quality Review in the eyes of bankers by Silvia Merler on 27th June 2014 2114166 In December, we wrote a paper about the ECB’s comprehensive assessment and its aftermath. We identified significant uncertainty about the recapitalisation needs that would be identified by the ECB’s comprehensive assessment. Ernst and Young has published this week their European Banking Barometer for the first half of 2014, which gives a very interesting snapshot of the banking sector’s perceptions about macroeconomic outlook as well as an indication of their priorities for the next moths. Among other issues, it also includes interesting insights on banks perception of the capital needs that will result from the ECB’s assessment. Findings confirm that uncertainty still prevails.

Source: E&Y EBB – 2014 H1 The EBB builds on a survey of 294 interviews with senior bankers across 11 markets: Austria, Belgium, France, Germany, Italy, the Netherlands, the Nordics, Poland, Spain, Switzerland and the UK. To ensure that the cross-countries differences in banking systems are taken into account, a range of bank types was interviewed including universal banks (large-scale banking group/major bank); corporate and investment banks; private bank/wealth managers; specialist (e.g., consumer credit, savings, or a bank that doesn’t offer a current account) and retail and business (e.g. SME business banking). Interestingly, this edition includes questions on the ECB’s Asset Quality Review and Stress Tests. Few months ago, we published a paper on recapitalization and restructuring after the ECB’s exercise, pointing out that – at that time – one of the most important elements of uncertainty was in fact the amount of expected recapitalisation needs. At that time, a survey of market research and academic papers revealed very divergent view, ranging from an optimist 50bn to a pessimist more than 600bn. E&Y analysis shows that uncertainty about the results of the ECB’s investigation still prevails in the industry, despite the recent waves of capital raises by banks[1]. While only 8% of

respondents anticipate raising additional capital following the exercise, there is an additional 19% of respondents who a capital raise “might” be necessary.

Source: E&Y EBB – 2014 H1 While being more optimistic on the economic outlook, banks remain worried about Non-Performing Loans (NPLs), with almost one third of respondents still expecting to raise Loan Loss Provisions in anticipation of the AQR. The report highlights that this is particularly true in Spain, where banks have been required to revalue their real estate portfolios, and in Austria where banks have significant exposure to Eastern Europe.

Source: E&Y EBB – 2014 H1 Banks also anticipate that the sector will undergo structural changes in a not-so-far future. 65% of respondents expect medium-to-large consolidations within three years, with Italian banks expecting the greatest consolidation of their sector – both in the short and medium term. Concerning the prospects for corporate lending, the survey shows an improvement over time in most sectors. The outlook seems particularly positive for SMEs, where 45% of respondents expect lending to be less restrictive. If realistic, this would certainly be an encouraging signal about the potential take-up of the recently announced TLTRO and for the participation in any SME-related asset-purchase programme that the ECB were to announce.

______[1] Several banks have already raised capital levels ahead of the AQR and stress tests. According to Thomson ONE, by the time we completed fieldwork for this survey, Eurozone banks had already raised over US $11 billion of equity this year, compared with just over US $2 billion in the same period in 2013. Since we completed the fieldwork, banks have raised an additional US $24 billion, bringing the total equity raised this year to over US $35 billion. | Read more at Bruegel http://www.bruegel.org/nc/blog/detail/article/1371-fact-of-the- week-only-8-percent-of-banks-says-they-will-need-to-raise-capital-after- aqr/?utm_source=Bruegel+Fact+of+the+Week&utm_campaign=d097b9eee8- Bruegel+FotW_Week_27_2014&utm_medium=email&utm_term=0_397314f092- d097b9eee8-277671613

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BPI 84º Informe Anual 2013/14 29 de junio de 2014 La política monetaria necesita una nueva brújula para ayudar a la economía mundial a salir de la sombra de la gran crisis financiera. Para ello, habrá que ajustar la actual combinación de políticas y los marcos de política económica para poder retomar un crecimiento económico sostenible y equilibrado. La economía mundial ha mostrado síntomas alentadores durante el último año, pero aún no ha finalizado su convalecencia tras la crisis (Capítulo III). Pese a una búsqueda agresiva y generalizada de rentabilidad, con una volatilidad y unos diferenciales de crédito cayendo hasta mínimos históricos (Capítulo II), y unas condiciones monetarias inusualmente acomodaticias (Capítulo V), la inversión sigue siendo débil. La deuda, tanto pública como privada, sigue aumentando mientras el crecimiento de la productividad ha ampliado aún más su tendencia descendente de largo plazo (Capítulos III y IV). Se habla incluso de estancamiento secular. Algunos bancos se han recapitalizado y han ajustado sus modelos de negocio, mientras que a otros aún les queda mucho por hacer (Capítulo VI). Para recuperar un crecimiento sostenible y equilibrado, las políticas deben ir más allá de su enfoque tradicional centrado en el ciclo económico para adoptar una perspectiva de más largo plazo que gire en torno al ciclo financiero (Capítulo I). Es necesario que aborden frontalmente las deficiencias estructurales y la mala asignación de recursos que 54

los fuertes auges financieros ocultaron y que solo se revelaron en las posteriores contracciones. La única fuente de prosperidad duradera es una mayor fortaleza por el lado de la oferta. Es esencial prescindir de la deuda como principal motor de crecimiento. Resumen de los capítulos económicos 84° Informe Anual por capítulos

Índice, Carta de presentación 7 pages

I. En busca de una nueva brújula 17 pages La economía mundial ha dado síntomas alentadores durante el último año. Pero sus dolencias persisten, al seguir presente el legado de la gran crisis financiera y las fuerzas que condujeron a ella. More...

II. Los mercados financieros mundiales obnubilados por la política monetaria 19 pages Los mercados financieros han sido muy sensibles a la política monetaria, tanto por las medidas efectivas, como por las esperadas. A lo largo del año, la relajación de la política monetaria mantuvo estables las tasas de interés en niveles bajos, fomentando la búsqueda de rentabilidad. More...

III. Crecimiento e inflación: catalizadores y perspectivas 26 pages El crecimiento económico mundial ha repuntado, impulsado sobre todo por las economías avanzadas, al tiempo que la inflación ha seguido contenida. Pese a su actual aceleración, el crecimiento en las economías avanzadas continúa por debajo de los promedios anteriores a la crisis. More...

IV. La deuda y el ciclo financiero a escalas nacional e internacional 22 pages Los ciclos financieros recogen las interacciones entre percepciones de valor y riesgo, asunción de riesgos y condiciones de financiación, que se traducen en fases de expansión y contracción. Los ciclos financieros suelen ser de mayor duración que los tradicionales ciclos económicos. More...

V. La política monetaria pugna por normalizarse 21 pages La política monetaria se ha mantenido muy acomodaticia mientras afrontaba varios retos complicados. En primer lugar, en las principales economías avanzadas, los bancos centrales se enfrentaron a una recuperación inusualmente lenta y a indicios de pérdida de eficacia de la política monetaria. More...

VI. El sistema financiero en la encrucijada 23 pages El sector financiero ha recuperado tras la crisis parte de su solidez. Los bancos han reforzado su capital (fundamentalmente a través de beneficios no distribuidos) y muchos de ellos han reorientado sus modelos de negocio hacia la banca tradicional. More...

El BPI: misión, actividades, buen gobierno y resultado financiero 123 pages Full text// PDF 278 pages, 2.800 kb// Press reléase// 29 de junio de 2014 Related information// BIS Annual General Meeting 2014// Data behind all Annual Report graphs (xlsx) More Annual Reports in Spanish

2014 Privacy policy http://www.bis.org/publ/arpdf/ar2014e.htm 55

ft.com comment Columnists June 29, 2014 2:35 pm An investment surge would jolt Europe back to life

Wolfgang Münchau Giving the banks more money for lending is surely not the answer to a demand problem

As the next president of the European Commission, Jean-Claude Juncker cannot do much to help David Cameron. But he can help fix the eurozone – and this will probably be his single most important job in the next five years. It will invariably require a greater degree of policy centralisation – exactly the opposite of what the British prime minister is demanding. It is not only diplomacy that drives Mr Cameron and other leaders apart. Fundamental economic interests are at least as important. For the eurozone the most acute task will be to reverse the dramatic fall in investment. It is an EU-wide problem, but in the eurozone it has proved more persistent than elsewhere. There, gross fixed capital formation – much of which consists of investment by businesses – fell by 18 per cent in real terms between the end of 2007 until last year, with no sign of a turnround yet. In the UK, it fell by 22 per cent – but most of that decline occurred in 2008 and 2009. It was essentially flat between 2010 and 2013, and is now picking up. More ON THIS STORY// UK business investment bounces back/ Business warns over Italy’s weak growth/ Surveys damp hopes of eurozone recovery/ Matthew Vincent: False sense of security/ Markets Insight Europe rethinks how to cure debt hangover WOLFGANG MÜNCHAU// Merkel versus Renzi/ Europe’s debt horrors/ Europe’s drifters wait/ Italian rescue 56

The fall in private sector investment is the inevitable result of the debt build-up that took place last decade. Now, companies and households are spending less because they are paying back their debts. When that happens, the economy is in a so-called balance sheet recession. In some countries, such as Italy, it was made worse when the banks also cut back on lending. The fall in public sector investment is also easily explained. It is a direct effect of austerity. Governments find it easier to cut down on investment rather than current spending when they need to rein in deficits. In Italy, governments even stopped paying bills to suppliers. Economically, this is the least sensible way to apply austerity. It destroys jobs and companies, and reduces the productive capacity of the economy in the long run. Since this started some time ago, the long run is where we are today. What can the commission do? On the surface, the options are limited. The fiscal rules, if generously interpreted, allow some flexibility. But much of that flexibility is already being applied. The real constraint on Italy, for example, is not the rule that restricts annual deficits to 3 per cent of gross domestic product. Its problem lies in a debt-to- output ratio that is 135 per cent and still rising. Without growth, deficit spending cannot carry on forever. In Germany, gross fixed capital formation declined in 2012 and 2013. It, too, needs to do more, but is constrained by a constitutional budget rule that limits the structural deficit to 0.35 per cent of GDP. The coalition agreement in 2013 foresees only a negligible increase in public sector investment. The constraint here is not Brussels, but German constitutional law. Can the problem be solved at EU level? The EU budget, at about 1 per cent of GDP, is tiny – and most of it is earmarked for existing programmes. Mr Juncker will need to create a consensus in favour of higher public investment across the EU, and he will need to find an ingenious way to finance it Another route through which the EU traditionally gives incentives for investment is the European Investment Bank. In 2012, EU leaders increased the EIB’s capital to boost lending by some €20bn a year from 2013 to 2015. But it failed to bring about the needed boost to investment for a number of reasons. There are onerous co-funding rules, which require the EIB to look for co-investors whenever it commits cash. A fall in demand for credit was also a factor. So what is left? The easiest solution, in theory, would be for the EU itself to issue a bond, and simply start investing the money, for example in EU-wide infrastructure or energy networks. Call them stability bonds instead of euro bonds, if that makes the idea more palatable in Berlin. And then let the European Central Bank buy those bonds; just do not talk about debt monetisation. This would solve two problems – insufficient investment and excessively low inflation – with a single instrument. There is a catch. This is almost certainly too radical a proposal for European institutions, for both political and legal reasons. All the same, they need to find a scheme that can raise aggregate investment. Perhaps the answer lies in a mixture of measures. The commission could exempt certain investments from the penalty procedure for excessive deficits. It could propose further EIB lending. But I fear that neither is going to be sufficient. Mr Juncker will need to create a consensus in favour of higher public investment across the EU, and he will need to find an ingenious way to finance it. 57

The commission could also play a useful role in moving the EU towards a grand debt resolution conference, to help lighten the unsustainable debts that weigh on balance sheets across the eurozone. This issue will rise up the agenda once it becomes clearer that debt levels are not falling fast enough. Mr Juncker’s campaign has left me unsure whether he will address these issues with the needed sense of urgency. For now I shall withhold judgment. But the incoming president needs to understand that there is little time to waste. http://www.ft.com/intl/cms/s/0/e02c9154-fdf2-11e3-bd0e- 00144feab7de.html#axzz367A6WrR0

ft. com World Europe June 29, 2014 7:02 pm Transcript: FT interview with Wolfgang Schaüble By Stefan Wagstyl and Jeevan Vasagar in Berlin

©Bloomberg This is a transcript of an interview with Wolfgang Schaüble, Germany’s finance minister, by Stefan Wagstyl, the FT’s chief Germany correspondent, and Jeevan Vasagar, the FT’s Berlin correspondent. FT: What are Germany’s priorities for the G7? More ON THIS STORY// German minister pledges to keep UK in EU/ Juncker to seek ‘solutions’ to UK concerns/ Wolfgang Münchau Europe needs investment/ Britain left isolated by Juncker defeat/ ‘Berlin first’ strategy backfires for Cameron ON THIS TOPIC// Business leaders urged to make EU case/ European companies take on pre-crisis levels of debt/ Q&A The Juncker fight and why it matters/ EU family businesses more optimistic IN EUROPE// Eurozone inflation unchanged at 0.5%/ Bulgaria’s leaders hold talks on banks/ French minister attacks tourist tax rise/ Kiev urged to take firmer actions in east Wolfgang Schaüble: Our priorities are, to pursue the objectives that we always work for in the G7 forum . . . And of course the paramount theme is how we can achieve sustainable growth. That is the big challenge ...... And of course the decisive topic is, how we can strengthen investment activities. There is consensus about that – more investment, more vigorous structural reforms. The transition in the global economy moves at a frantic pace. And we co-ordinate and seek to have collective positions, so that we can convince others. Besides, the regulation of financial markets and the struggle against tax evasion, and the reduction of tax flexibility to the level that is compatible with the rules of fairness. These are the main themes . . . FT: The leadership of southern European countries, including the Italian prime minister Matteo Renzi, would like more flexibility in the eurozone stability pact to accelerate the path to growth. Aren’t you, as a supporter of tight fiscal discipline, losing this argument?

WS: In Europe, I haven’t heard this demand either from the Italian prime minister or from anyone else . . . We all agree that sustainable growth requires structural reforms and sustainable, operational, stable, institutional parameters. And that requires besides – indisputably, and the IMF says this again and again – a soundly-balanced, calibrated and constant repayment of excessive debt, both with public budgets and with private debt. And we are at a historically excessive level of debt as a consequence of the great financial crises. And what is constantly being discussed is in what way the monetary policy of the central banks can support this development, [but] if you accept the statements of the European Central Bank, then you know that the bank urges structural reforms, which are essential. The ECB says it does what monetary policy allows. But it cannot substitute for political decisions. And therefore we will stand up for that in Europe, albeit with the greatest respect. We [in Germany] are the proof that a repayment of excessive debt and sustainable growth are not opposites, but reciprocal conditions. We have better growth figures than most of our partners in the euro zone and our key financial figures are solid. FT: But Sigmar Gabriel, the social democrat leader and your coalition partner, has clearly demanded greater flexibility. Are you agreed on this within the coalition? WS: We have clear arrangements within the coalition. Besides, I am the finance minister in this federal government and we’re doing this on the basis of this collective arrangement. Mr Gabriel has explicitly stated that he does not demand any adjustment in the European excessive deficit procedure – quite the opposite. That is, as I always say – we mustn’t talk about adjustments we have to do what it states in the rules! We must do what is agreed. We have to implement. The problem in Europe is not the rules but the implementation – sometimes. FT: Are you afraid that too much financial discipline will drive the voters to populist parties? In France for example, in the last European Parliament elections. WS: When you establish a connection between the share of the vote for eurosceptic, demagogic and populist groups, then I’ll say to you, one can clearly show: Germany has relatively solid financial figures, and relatively few eurosceptic votes. FT: Isn’t Germany quite different from other European countries? WS: Why are we quite different? We are the biggest economy in the European space but we have a quite strong linkage with other European states . . . The German export success of German business also helps others in Europe . . . The eurozone as a whole has a level external balance. Without our contribution, we would, in relation to the rest of the world, have a rather serious situation. That means our development . . . is compatible with Europe. We are a growth locomotive ...... We have, in historical terms, a record level of debt in comparison to GDP in the industrialised countries. We have reached the level of the end of world war two. We are convinced that . . . an excess of debt is not positive for growth but has quite the opposite effect. How do we generate growth? Through confidence among consumers and investors. We have in Germany a high level of consumer demand, which we have seldom had before. Our growth is basically driven by domestic demand. Investment requires confidence. 60

Structural reforms in the labour market in the institutional framework are often difficult to implement in the political short term. That is also true in Germany. But they are necessary . . . FT: How can we fight youth unemployment, for example in Spain? The level of youth unemployment in Spain will get better. Spain comes from a difficult place in the labour market, but the Spanish labour market has, since the start of last year, [improved] month by month. There is no really fast way out of such problems. [In Germany] we are looking for qualified young people. We are recruiting young people from other European states to come to Germany for training purposes ...... We believe that strengthening smaller and midsized businesses is also much better for employment…. . . . Also if we can – in the new legislative period of the European Parliament and Commission – become more efficient in the use of EU funds, then that will also help. The Italian prime minister has in the last few days talked about the €6bn that state and government heads have decided to use for fighting youth unemployment. That is not yet flowed out and because of this we have put off, for the moment, the special summit on youth unemployment in Turin. So, let’s improve efficiency and let’s not have so many debates over flexibility and new rules. [Effective] implementation is better. FT: The topic of financial regulation is important for the G7. Is it possible to end ‘too big to fail’? WS: We have similar regulatory approaches with minor differences in the USA, as in the United Kingdom, as in the European Union. In the EU we have the Liikanen report that is currently in the implementation phase . . . We have learnt the lessons from the experience of the financial and banking crisis, to improve the capitalisation of banks. That took place with Basel III and will be gradually implemented. We’re making progress in Europe on the way to making banking supervision more efficient . . . Therefore the creation of a European banking union is a milestone, we move forward with this development. And therefore, with all these mechanisms together, we can make the financial sector much more resilient than it was up to now . . . How one divides proprietary trading from market-oriented, customer-oriented business is indeed a rather difficult problem, [which is] why each regulation is either enormously detailed, or takes the route of giving the supervisor great discretion in individual cases. And with the creation of European banking union, we’re going along the way to making banking supervision more efficient in the eurozone . . . equipping it with stronger decision-making possibilities, a way that, yes, the Anglo-Saxons have sketched out. FT: But the question is what happens when supervision fails, when there’s a fresh crisis? Then governments have to decide, don’t they? WS: Of course, the rules must be set so that one can wind up banks without the taxpayer, without the public budget. Therefore the question is not just of core tier one Capital, but above all things the so-called GLAC [the gone-concern loss-absorbing

capacity], that one has enough bail-in-capable capital. Therefore we are also strongly in favour that one strengthens the demands [on shareholders and bondholders]. Our goal is that we rule out the moral hazard problem with big banks, and interconnected ones. Too-big-to-fail or too-interconnected-to-fail is in the long run no solution. Tim Geithner [former US Treasury secretary] always distinguishes between Wall Street and Main Street. That is a lovely verbal image. What Main Street wants is that in the end taxpayers aren’t liable. . . . The BRRD [bank recovery and resolution directive] is a very important step. The finance industry itself finances a fund so that when it is necessary, we have the means. That is designated in the BRRD, and designated in the European Resolution Mechanism, in the SRM [Single Resolution Mechanism], and with a Single Resolution Fund up to €55bn. Besides, we established a clear bail-in hierarchy with at least 8 per cent bail-in that is quite sufficient. FT: Has the debate about Jean-Claude Juncker damaged the EU? WS: I don’t know, if the EU has been damaged. Democracy always involves arguments, and European integration is a development which is seen a bit differently in the [different] member states. Therefore if you want to be successful in European integration you have to have regard for one another. That’s why Europe seems to outsiders always a little complicated, a little slow in decision-making. But I am quite confident. I find that what we Europeans have brought about with this integration process over 65 years now, is quite remarkable . . . And now we have this step, a development over the question of which role the commission and the European Parliament will play in the future . . . You Britons have, if I have this right, strongly promoted parliamentarianism in European history. And that must also take place in Europe. [Mr Schäuble later said via email: “We have seen time and time again that in conflicts between executives and parliaments, parliaments tend to prevail.”] Of course I know, that one would rather in the past have such decisions at . . . the European Council, so that the state and government heads had to make a collective proposal. Until now one has always come to an understanding. But the treaty provisions mean that one can make a proposal with a qualified majority. And it’s no disaster, if on one occasion you decide with a qualified majority. [But] . . . The UK is an essential, indispensable component of the European unity. The EU without the UK is absolutely not acceptable, unimaginable. Therefore we have to do everything, so that the interests and the positions of the UK find themselves sufficiently [represented] in European politics. That is exactly the thing that the German chancellor [Angela Merkel] repeatedly tries to do. And one must also have respect for the domestic political developments in each individual country . . . And then in the end Europe is strong enough to get through despite it . . . FT: Why is the UK so important? WS: Europe without Great Britain is not Europe. Point one. Second, Great Britain is one of the most important [members] . . . Historically, politically, democratically,

culturally, Great Britain is entirely indispensable for Europe, and besides, Great Britain is one of the biggest economies in Europe and by a great distance one of the most important financial centres of the world. And, as hard as it is to conceive of football without Great Britain – even when it [England] has been eliminated from a World Cup – that’s how hard it is to think of Europe without the UK. FT: Is the UK also a partner for Germany, for economic reforms in the EU? WS: Clearly. We have in many economic questions and regulatory questions a broad consensus. One must see [that]: Europe is a continent with an incredible diversity of differences, with an incredible wealth of varied cultural heritage and – with all respect – in this diversity we’re not comparable with any other continent. And when one thinks of that, then one can have more understanding for the fact for example that the implementation of agreed-upon rules in different parts of Europe, is different. That doesn’t mean that some have a higher moral quality than others. That’s nonsense. But we have different traditions . . . [Mr Schäuble later said via email: “It is not just Germany that should reach out to the UK. The UK is vital to the EU and all its institutions and member states should listen to what London has to say. We have lots of common ground with her majesty‘s government for example with regard to economic reforms, to the effective use of EU funds and to a strong preference for subsidiarity in decision-making. And we agree Europe cannot afford to stand still during the next legislature but must tackle urgently needed structural reforms to boost growth.”] We have a great power of attraction. If I understand it correctly, it disturbs Mr [Vladimir] Putin, [the Russian president], that Europe has too much attractiveness, rather than too little. I say that Mr Putin should not be disturbed by this power of attraction, but grasp the fact that close co-operation with Europe is the best, for the long-term interest of Russia, and Europe is ready for that. One just has to keep to the rules. FT: Don’t you think that Mr Putin is a threat for Europe as well as for Ukraine? WS: I haven’t used the word threat . . . We say repeatedly that we want a close partnership with Russia. The closer the better. But the condition for a partnership is that you keep international law and the rules that go with it. That is indispensable. And therefore will try to do two things at once – to be as reasonable as possible and to be as unprovocative as possible, but at the same time to be so clear that nobody can doubt our decisiveness and determination. We don’t threaten anyone and we also don’t want anyone to threaten us . . . Europe is not to be intimidated by anybody. FT: But you yourself compared the assault on Crimea to Hitler’s assault on the Sudetenland? WS: No, I did not. I said [in a discussion with pupils during a school visit] that there are certain methods which are not unknown in history . . . When you look back at this and then see what kind of conflicts these are [in Ukraine], then it is quite clear: whoever begins, again, to incite ethnic group conflicts and exploit them politically . . . whoever incites such conflicts especially at times of economic need or political instability in order to stir up people against each other . . . is wrong. And this was a method that is not

new in history . . . I did not compare President Putin with anybody. And I know well: we Germans don’t compare anybody with Hitler. FT: Do you think that perhaps stronger sanctions should be applied against Russia? WS: That lies entirely in Russia’s hands. We don’t want sanctions. But if we don’t return to the fundamentals of international co-operation and international law, and if the independence and self-determination of nations are not respected, then it is inevitable that this really has consequences. And since we no longer can solve conflicts in Europe with military means and don’t want to do so, we must be clear: that leads then to a worsening of economic and political relations. You can also call that sanctions. FT: The eurozone. You have recently proposed reforms for the eurozone, for example a permanent secretariat and a parliament for the eurozone. How important are such institutional reforms? Can’t the eurozone get by without them? WS: In any event, things will go better with reforms. I think that for the Financial Times it was a bit of a surprise that the euro is so stable. That it is much better than you had supposed. But you see with reforms it would have been better . . . As [UK] Prime minister David Cameron has always said: ‘You have this common European currency. It can only be founded on a common monetary policy. You need a common financial and economic policy. Make the euro strong. Otherwise the economy of Great Britain will also suffer.’ And the intergovernmental agreements with which we have partly solved the problems are complicated. They are always only, in a way, second-best solutions. And that is why the [German] federal government still has the view that we should, through institutional changes, improve the possibilities of pursuing common financial and economic policies . . . The European Parliament has said that it cannot be right that in all these decisions the European institutions do not have a decisive voice . . . If we want sustainable growth in Europe, if we want to fight unemployment more quickly and more efficiently, including youth unemployment, then we should not leave everything to monetary policy . . . The common currency makes demands of the financial and economic policies of the participants of this currency. FT: You said before the European Parliament elections that the time for reforms would come after the elections? Do you have concrete reform plans for the next few months? WS: You know it is complicated to carry out decisions in Europe. The German government has clear plans . . . How we now get there step by step is as always a more complicated process. [Mr Schäuble lists the EU summit, parliament’s likely response, and the creation of the new commission, all with parliament playing a bigger role] . . . FT: So can the reforms come in autumn, in winter, next year? WS: The sooner the better. FT: How far can one go with reforms without EU treaty changes? WS: You know, the German government is arguing for limited treaty changes. We must see, whether they can be achieved. But I think the chances are not so bad. If I follow 64

correctly the position of her majesty’s government, then prime minister Cameron is also demanding specific changes in the European rule book. The next question is whether radical changers in the European fundamental laws – that is treaty changes – are necessary or possible. There is a series of member states in which the representatives of these countries say: “We would face great domestic political difficulties consenting to treaty changes in the light of the rules of our national constitution.” That is true for Finland, I think, without even mentioning Ireland. It applies to Austria. So the picture is varied. I think the Netherlands would also not do this lightly . . . FT: Which of these reforms is a priority? The secretariat? The European Parliament? What? WS: . . . Today, one of the finance ministers of the members of the eurozone does this and we have so far done well with this rule . . . So the federal government does not view the question of a permanent chairman as a priority. For us it is much more important that we achieve improvements in the matter of decision-making, in rules and in implementation, in efficiency and in the binding nature of decisions ...... We can take concrete steps in the current framework . . . with a stronger role for EU institutions, as the parliament will demand, and meeting as before, as the eurogroup of finance ministers one day, and as Ecofin, the EU finance ministers, the next . . . And so naturally in fact compliance with the agreed rules is of great importance. That builds trust, and without trust it is much more complicated. The German government has pointed out this out again and again. The rules of the deficit procedure, the stability pact and, in fact, of EU law. The application of European law should be entrusted to the commission as much as possible. [For example], the competition commissioner has a very strong role when it comes to applying the rules of the single market, and that must be respected by all. And if the budget commissioner or the commission as a whole had the appropriate possibilities, that would be a confidence-building measure. FT: And so one can make fairly big improvements without treaty changes? I think you can come up with a limited treaty changes which can be managed quite well, so that you need no great convention . . . We once suggested that one could rework Protocol 14 [of the Lisbon Treaty] a bit in terms of content for the eurozone, because today it is, so to speak, an empty shell. . . . But if you are a practising politician, you have to also remember that putting something into the EU treaty rules requires a unanimous decision and ratification in all member countries. FT: Why has enthusiasm for the EU fallen in some countries? WS: Has it really fallen? . . . Depending on how deeply you do the analysis, you determine that in many European countries, European unity is – at its core – barely questioned by the vast majority. Because people have understood, that in the 21st century the framework conditions for our life, for our economic possibilities, for political possibilities, for political stability, are not decided by us alone. In a globalised 65

world, developments in every corner of the world have enormous influences on us, not just economic ones . . . One can only perceive fairly our responsibility and play our role as Europeans, when Europe acts together. European unity is the correct answer to globalisation in this 21st century. FT: What of popular enthusiasm? WS: So long as things go fairly well, the population is not so enthusiastic. One can’t be so ‘football crazy’ all year round as many people are at the moment . . . I believe that were this European project of peace, democracy, stability and the rule of law to be substantially endangered, the enthusiasm for it would be great once again. FT: Are you concerned about the future of France? WS: France is a strong country. But France has – again, in comparison to other European states – an extraordinarily high level of social benefits and regulations . . . France has a long tradition of a very centralised system. You can have very different opinions over whether overly centralised systems in the rapid changes of globalisation, through the development of modern technology, are still sufficiently flexible or innovative. . . . We Germans are slightly mocked for our social market economy, our Rhineland capitalism – incidentally, especially by the Anglo-Saxons. [But] when we went through the experiences of the financial crisis that came out of Lehmann Brothers, a lot of people envied us our social partnerships. Because they understood that a certain common responsibility from employers, entrepreneurs and employees or trade unions [supports] the capacity for change in a wealthy society . . . In wealthy societies the readiness for change is not so great. You demand changes for other people but for yourself you prefer not to have so many changes. Therefore it is not bad to have a certain consensus to push through reforms. President [François] Hollande is working on this in France. That’s why he has proposed this social pact . . . France will solve these problems. Of that I am confident. FT: Is it possible that in the current political atmosphere we can successfully negotiate the Transatlantic Trade Agreement? WS: I hope so. The federal government is firmly convinced of its advantages. We are lobbying for it. It is an important task for the commission too, in the next legislative period . . . The benefits are obvious for all stakeholders. And then our American friends must fulfil their promises, as President [Barack] Obama says repeatedly, one can only lobby for rules, and values and goals, when these rules also apply to oneself – that’s reciprocity. That has to be promoted in the United States of America. http://www.ft.com/intl/cms/s/0/f5312b00-ff96-11e3-8a35- 00144feab7de.html#axzz367A6WrR0

The Irish Times Business German think tank advocates new EU bonds to boost growth Derek Scally Last Updated: Sunday, June 29, 2014, 23:12 Ireland’s investment gap is the highest in the euro zone at 9.4 per cent of annual economic output (gross domestic product), a leading German economic institute has warned. To close the gap and stimulate the real economy, Berlin’s Institute for Economic Research (DIW) proposes issuing new EU investment bonds, with the new Strategic Banking Corporation of Ireland financing a national investment agenda. DIW economists say such a co-ordinated programme at European level could pump capital into the real economy to drive growth, side-stepping traditional definitions of state borrowing that would shatter the 3 per cent deficit ceiling in the stability and growth pact. The German proposals make for interesting reading ahead of Taoiseach Enda Kenny’s visit to Berlin on Thursday, where he holds bilateral talks with Chancellor Angela Merkel and addresses the economic council of her Christian Democratic Union (CDU). Investment shortfall The DIW study compared euro zone countries’ current total investment – in big ticket items such as machinery, factories, roads and bridges – with the total needed to generate stable growth. Ireland is the country with by far the largest investment gap of 9.4 per cent, almost twice the Dutch investment gap of 4.8 per cent. The average gap in the euro zone, according to the DIW research, is 2 per cent of total GDP, or €200 billion annually in absolute numbers. An investment gap is evident right across the continent and dates back to before the euro crisis, the DIW economists write, but has been exacerbated by recent turbulence. In essence, the DIW is proposing a structure similar to the European Stability Mechanism bailout fund, with a focus instead on the shortfall in lending and investment that is squeezing the real economy. The DIW’s solution is a five-year special investment plan overseen by the European Investment Fund, part of the European Investment Bank. Its proposal would see the fund raising its own capital by issuing bonds guaranteed by EU member states. Their backing would guarantee low interest rates from investors, a financial benefit which could be passed on to borrowers. “Such a fund would be particularly helpful in Ireland, building up new capacity by stimulating private investment and securing long-term growth potential,” said Dr Ferdinand Fichtner, DIW chief economist. The proposal is welcome news for Italian 67

prime minister Matteo Renzi, leading lobbying efforts for EU members to agree greater flexibility in existing debt rules. The DIW proposals are likely to be opposed by leading economic figures in Germany, but backing is likely from Dr Merkel’s Social Democratic Party (SPD) junior coalition partner and its leader, Sigmar Gabriel. In recent weeks Mr Gabriel has indicated understanding for calls from Italy and France for greater differentiation between day-to-day spending and long-term investment. Desire for leeway Already senior ECB officials have suggested some additional leeway might be desirable. “Investment has decreased too much in the crisis and it is needed for the future of the citizens . . . Governments need to create the right environment to stimulate private investment,” said ECB executive board member Benoît Cœuré to the Süddeutsche Zeitung on Saturday. In its annual report, the Bank for International Settlements urged governments not to abandon the path of fiscal sustainability. But “where need is great”, it urged governments to “catalyse private sector financing for carefully chosen infrastructure projects”. It has pegged Ireland’s investment gap even higher than the DIW – at 14 per cent. http://www.irishtimes.com/business/economy/german-think-tank-advocates-new- eu-bonds-to-boost-growth-1.1849491

Le Monde François Hollande réclame une vice- présidence pour la France dans l'Union européenne LE MONDE | 28.06.2014 à 09h49• Mis à jour le29.06.2014 à 11h08 |Par Nicolas Chapuis, Philippe Ricard et Jean-Pierre Stroobants (Bruxelles, bureau européen) Abonnez-vous à partir de 1 € Réagir Classer Partagerfacebooktwittergoogle +linkedinpinterest

Davi d Cameron, François Hollande et Angela Merkel au premier jour du sommet européen, le 26 juin. | AP/Geert Vanden Wijngaert François Hollande a tiré parmi les premiers. Jean-Claude Juncker à peine désigné pour la présidence de la Commission, le chef de l'Etat a réclamé vendredi 27 juin « une responsabilité importante » pour le commissaire français sous la forme d'une vice- présidence. La désignation du prochain patron de l'exécutif bruxellois donne le coup d'envoi d'un vaste jeu de carrousel. M. Juncker s'est dit « fier et honoré » d'être retenu. Il devrait être investi par le Parlement européen le 16 juillet. Un nouveau Conseil européen se réunira aussitôt ce jour-là pour désigner les titulaires des autres postes en lice : Haut représentant pour la politique extérieure, président du Conseil et, sûrement, président de l'Eurogroupe. Lire aussi le portrait de Jean-Claude Juncker, le revenant De la Danoise Helle Thorning-Schmidt à l'Italien Enrico Letta, différents noms circulent. Leur répartition tiendra compte d'une série d'équilibres à trouver. Ils sont politiques (entre les conservateurs du Parti populaire européen et les sociaux- démocrates), géographiques (entre l'Est et l'Ouest) ou relèvent de la parité : au moins l'un de ces responsables devra être une femme. Sans oublier l'appartenance ou pas à l'union monétaire. 69

La nomination, en 2009, du trio José Manuel Barroso à la Commission (PPE, portugais), Herman Van Rompuy au Conseil (PPE, belge) et Catherine Ashton au poste de haut représentant (travailliste britannique) avait tenu compte de ces paramètres. Celle de leurs successeurs, outre M. Juncker, devra répondre aux mêmes... 27 juin 2014 Selon quels critères seront attribués les prochains postes européens ? La France s’est ralliée à la nomination de Jean-Claude Juncker au poste de président de la Commission européenne mais réclamera « une responsabilité importante » au sein de celle-ci, a indiqué, vendredi, François Hollande à l’issue du sommet des Vingt-Huit à Bruxelles. « Je souhaiterais une nouvelle organisation autour de grandes vice- présidences regroupant des secteurs importants et j’en demanderai une pour la France », a indiqué le président. Il n’a, en revanche, pas dévoilé quel en serait le titulaire. Les prétendants connus pour un poste européen sont Pierre Moscovici, Jean-Marc Ayrault et Elisabeth Guigou. « Je ne voulais pas de confusion des étapes », a poursuivi M. Hollande. Jean-Claude Juncker devrait être investi par le Parlement européen à la mi-juillet et un nouveau Conseil se réunira le 16 pour envisager les nominations des autres responsables européens (Haut représentant pour la politique extérieure, président du Conseil et président de l’Eurogroupe). Une série de noms continue de circuler pour ces différents postes. Leur répartition tiendra compte d’une série d’équilibres à trouver. Ils sont politiques (entre les conservateurs du PPE et les sociaux-démocrates), géographiques (entre l’Est et l’Ouest) mais aussi dictés par la parité : l’un de ces responsables devra être une femme. La nomination, en 2009, du trio José Manuel Barroso (PPE portugais à la Commission), Herman Van Rompuy (PPE belge au Conseil) et Catherine Ashton (travailliste britannique au poste de haut représentant) avait tenu compte de ces paramètres. Celle de leur successeur, outre M. Juncker, devra répondre aux mêmes conditions et devrait dès lors ménager l’une ou l’autre surprise. Comme en 2009, quand M. Van Rompuy avait refusé le poste avant de l’accepter (contraint et forcé, a-t-il dit) et qu’aucun pronostiqueur n’avait misé sur Mme Ashton. Jean-Pierre Stroobants

Le Monde Jean-Claude Juncker, le revenant LE MONDE | 26.06.2014 à 11h16• Mis à jour le28.06.2014 à 11h43 |Par Philippe Ricard et Jean-Pierre Stroobants (Bruxelles, bureau européen)

Jean-Claude Juncker, à Bruxelles, en mai. | Gaël Turine / Vu pour le Monde Le 27 mai, un Jean-Claude Juncker redevenu fringant et combatif a tenté de forcer le destin. Lors d'un sommet des dirigeants du Parti populaire européen (PPE), la formation arrivée en tête du scrutin européen deux jours plus tôt, le chef de file de la droite réclame un mandat pour mener lui-même les tractations avec le Parlement européen en vue de son élection à la présidence de la Commission. Peine perdue. Il se heurte à Angela Merkel, qui préfère confier au président du Conseil, Herman Van Rompuy, une mission de déminage : la chancelière allemande espère encore, ce jour-là, éviter une crise avec le Royaume-Uni et David Cameron, lequel juge M. Juncker trop fédéraliste. Lire aussi : Le combat perdu de M. Cameron contre M. Juncker 71

Le clash est passé presque inaperçu, mais en dit long sur les arrière-pensées de la chancelière dans cette affaire, ainsi que sur la détermination de M. Juncker à remplacer José Manuel Barroso, le président sortant. Au printemps, Angela Merkel avait accepté du bout des lèvres la candidature du Luxembourgeois, préféré au Français Michel Barnier, pour mener la campagne électorale de la droite. Elle pensait alors être en mesure de l'écarter après le scrutin pour placer une personnalité plus en ligne avec les souhaits de David Cameron. Début mai, Mme Merkel est même allée sonder les intentions de Christine Lagarde, à Washington, avant de comprendre que François Hollande n'accepterait pas de soutenir la directrice générale du Fonds monétaire international, ancienne ministre de Nicolas Sarkozy. Mais rien ne va se dérouler comme l'espère la chancelière. Ce 27 mai, juste avant de regagner Berlin après un dîner informel organisé avec ses homologues des Vingt-Huit, elle est, face à la presse, assaillie de questions sur son rôle dans cette affaire. Elle comprend qu'elle ne peut plus refuser le poste au candidat de son parti, soutenu par une probable majorité d'eurodéputés. « Une obligation démocratique », jugent en choeur les éditorialistes allemands et les élus de son parti, la CDU-CSU, tandis que la presse britannique se déchaîne contre celui que David Cameron range parmi les « hommes du passé ». En version tabloïd, cela donne « L'homme le plus dangereux d'Europe », dans The Sun. Pour la première fois de sa vie, M. Juncker voit alors des paparazzis camper devant son domicile luxembourgeois. Une sorte d'insulte pour ce dirigeant qui a, jusqu'ici, soigneusement dissimulé sa vie privée. On sait seulement que son épouse lui aurait confié qu'elle refuserait, à tout jamais, d'être son « pot de fleurs »… M. Juncker ne mérite, en réalité, ni tant de haine ni tant de passion. Pendant des années, ce vétéran de la construction européenne, et de l'euro, ministre des finances pendant les négociations du traité de Maastricht, s'est taillé une réputation d'homme de consensus. Il s'est fait une spécialité de jouer les tampons entre la France et l'Allemagne, avant et pendant la crise de l'Union monétaire. « Il est parfois considéré, de part et d'autre du Rhin comme le plus petit dénominateur commun, longtemps placé à la tête de l'Eurogroupe pour ne pas déranger », reconnaît un ancien commissaire français. Ce qui ne l'a pas empêché de ménager les intérêts du Grand-Duché, afin de préserver le plus longtemps possible ce secret bancaire et ce dumping fiscal qui ont fait la fortune de la place financière luxembourgeoise. UN HOMME AU CARNET D'ADRESSES RICHE Sa longévité au poste de premier ministre du Luxembourg – dix-huit ans, avant sa chute en décembre 2013, pour une sombre affaire de services secrets mal encadrés – en a fait un vieil habitué des réunions européennes. Un homme au carnet d'adresses riche en amitiés – et en petits calculs. « Il aime les gens, il a le contact facile et une réelle capacité d'empathie », explique une fonctionnaire luxembourgeoise. Elle se souvient de l'avoir vu, lors d'un grand tournoi de football, sortir de sa voiture alors que la route était bloquée et célébrer une victoire avec des supporteurs portugais. Son équipe favorite, paraît-il. Information non recoupée, mais on relèvera que les Portugais forment la plus importante communauté étrangère au Luxembourg. Qu'aime-t-il, en fait ? « La politique, rien que la politique », confesse l'un de ses amis. Il lit surtout des essais et des analyses… politiques. En particulier celles de l'historienne américaine Barbara Tuchman qui a dépeint les prémices de la première guerre mondiale dans The Guns of August (Août 14, Presse de la Cité, 1962) et raconté dans The March of Folly (La Marche folle de l'Histoire, Laffont, 1992), comment, de la guerre de Troie 72

à celle du Vietnam, les grands dirigeants commettent des erreurs qui peuvent conduire aux pires des désastres. La politique et l'Europe sont les deux moteurs de sa carrière. Il s'y est dévoué « corps et âme », assure l'un de ses anciens adjoints. Et c'est parce qu'il aime à rappeler le passé et l'idée que l'Europe est, avant tout, un gage de paix que l'image d'un « Juncker homme d'une époque révolue » s'est progressivement imposée. La campagne électorale que le PPE lui a mitonnée, avec force recours aux nouvelles technologies et aux réseaux sociaux, visait à corriger cette réputation. Un succès ? Sans doute pas. Guère convaincante, en tout cas, pour ceux qui savent que le candidat-président à la Commission écrit avec un stylo Montblanc et a appris sur le tard à envoyer un texto. Doté d'une énergie hors du commun, il ne se fait toutefois pas d'illusion : « La vie que je m'impose n'est pas bonne pour mon organisme », a-t-il parfois lâché à certains de ses collaborateurs après l'une de ces séances-marathon dont Bruxelles a le secret. Sa force : il est doté d'une bonne capacité de récupération. On l'a vu s'installer dans un siège de voiture, un fauteuil d'avion ou le canapé d'une salle d'attente et piquer illico du nez. Son talon d'Achille : une consommation que l'on dit importante de tabac et d'alcool dont s'est d'ailleurs moqué son successeur à la tête de l'Eurogroupe, le Néerlandais Jeroen Dijsselboem, dans une émission de divertissement. Depuis, il tente de se mettre à la cigarette électronique. Certains diplomates s'interrogent néanmoins sur sa capacité physique à tenir bon à la tête de la Commission – un paquebot dont le pilotage n'a rien à voir avec celui d'une cité-Etat. Pendant la campagne, le « candidat » du PPE est apparu usé par ces années de crise de l'euro, et facilement irritable. « Les débats ne servent à rien », lui est-il arrivé de lâcher alors que son équipe l'astreignait à faire le tour d'Europe et des plateaux télévisés. Son image n'est d'ailleurs pas son principal souci. Il lui arrive de sourire de ce qui s'écrit sur lui dans les journaux. Sauf quand des tabloïds britanniques affirment que son père était un sympathisant nazi – il fut, en réalité, enrôlé de force dans la Wehrmacht, comme de nombreux jeunes Luxembourgeois. « HOMME LIBRE » L'essentiel, pour lui, semble être de s'afficher comme un homme détaché du pouvoir – même s'il en raffole. Quand il a vu, naguère, des postes européens lui filer sous le nez ou lorsque trois partis se sont coalisés pour l'éjecter du gouvernement de son pays, à la fin de 2013, il s'est efforcé de philosopher. Il a parlé de lui comme d'un « homme libre » qui n'aurait pas absolument besoin du pouvoir. Il a souligné qu'il n'était pas un « politicien de métier » et rappelé que son vrai métier fut celui d'avocat – même si à Luxembourg personne ne se souvient de l'avoir aperçu au barreau. Il a même affirmé qu'il pourrait un jour se convertir au journalisme – sans convaincre personne. Et pourquoi pas, en fait ? Car cet homme-là est capable de se fondre dans tous les milieux sans perdre sa spontanéité ni sa forme particulière d'humour qui a fini par agacer beaucoup de ses interlocuteurs mais qu'il continue de cultiver, en essayant cependant de la tempérer. Il sait que son amour des mots, si possible grinçants et piquants, lui a joué des tours – faisant même chuter le cours de l'euro à l'occasion – mais qu'elle plaît aux journalistes fatigués de la langue de bois des politiques et de l'eurocratie. Ce fan de la presse, qui dévore tout ce qui s'écrit, connaît les ressorts de la

sphère médiatique. « Il voit tout, lit tout, sait tout », sourit un ancien ministre qui l'a longtemps côtoyé. On ne devient pas le doyen des grand-messes bruxelloises sans susciter quelques inimitiés et frustrations. Nicolas Sarkozy le détestait et n'avait pas de mots assez durs pour critiquer son manque d'initiative au début de la crise financière. On n'efface pas non plus des positions à géométrie variable qui trahissent, pour le moins, une certaine inconstance. Ainsi, pressenti pour présider – déjà – la Commission de Bruxelles en 2004, quand Jacques Chirac lui demandait de délaisser son « département des eaux et forêts », il y renonçait pour honorer sa promesse aux électeurs grand-ducaux, auxquels il avait juré qu'il ne les quitterait pas. En 2009, tout en affirmant ne plus s'y intéresser, il a travaillé, en coulisses, à la conquête de la présidence du Conseil, finalement octroyée au Belge Herman Van Rompuy. Et après sa récente défaite politique à Luxembourg, il se voyait en chef de l'opposition à la Chambre des députés, avait-il affirmé dans l'incrédulité générale. Peut-être ces zigzags publics n'étaient-ils qu'une façon d'habiller une ambition qui, elle, n'a jamais changé de cap. Peut-être aussi les diatribes de David Cameron ont-elles finalement été le meilleur gage de la réussite du revenant : renoncer à M. Juncker aurait donné raison au premier ministre britannique et provoqué une grave crise avec le Parlement européen. Un scénario qui n'était pas du goût d'Angela Merkel, de François Hollande et de ses homologues continentaux. http://www.lemonde.fr/europe/article/2014/06/26/jean-claude-juncker-le- revenant_4445669_3214.html

Daily Morning Newsbriefing June 27, 2014 Merkel and Renzi clash over dinner Only the Italian press seems to have picked this up, while the others are still obsessing about Jean-Claude Juncker. At the dinner in Ypres, Matteo Renzi and Angela Merkel clashed over whether to be more specific about the broad agreement that fiscal rules should be interpreted flexibly. La Repubblica writes this morning that this was triggered by Renzi’s demands for more clarity over the fiscal rules. At dinner, Merkel is quoted as having said: “We have already conceded much, you should be satisfied. We cannot be more explicit.” Whereupon Renzi retorted: “We will not do what Germany did in 2003, but we want clarity that who undertakes reforms must have a right to more flexibility.” Renzi also supports the idea to eliminate co-funding from the Maastricht deficit calculations, as well as certain categories of public expenditure. Corriere della Sera has further details. The sherpas were due to work out a compromise on the work programme. Renzi was pushing particularly hard for clarity, and added that Italy was not alone in this request. Renzi said Juncker will only be nominated tomorrow after there is agreement on the programme. The Corriere article says that Luiz De Guindos is now tipped as the candidate most likely to be appointed for the eurogroup, given that Spain has no jobs in the ECB’s executive committee, though Pierre Moscovici was also still in the race. There was also renewed talk – in the Italian newspapers at least - about Enrico Letta as president of the European Council. The European liberals, ALDE, have decided to join the coalition of the PPE and the S&D. This is potentially significant as it allows Juncker to rely on a much broader support base. There was some doubt whether Juncker would receive an absolute majority if he was supported only by the S&D and the PPE as some PPE MEPs would not support Juncker. Sueddeutsche Zeitung says Angela Merkel wants to meet David Cameron half way on the substantive issue of economic reform – to neutralise some of the diplomatic poison over Juncker. The paper quotes the newly elected Finnish PM Alexander Stubb as saying that there could be more liberalisation of markets and more free trade. In Britain the debate on Juncker and Cameron became even more frantic. We leave this debate aside, except for this comment by Jeremy Warner who argued in the Daily Telegraph that the eurozone is a key reason for Britain’s isolation. “…For the rest of Europe, the single currency is driving a process of integration which must ultimately require some form of fiscal and political union. It’s still a long way off, but it is coming, and inevitably, it places Britain in a completely different, non participant role. Juncker makes no difference to the substance of this divergence, which is already in the stars, but his appointment might accelerate its realisation.” Here is the list of the committees, and the parties that will chair them. The Econ committee will be run by a Socialist: 75

Greece's unpaid taxes keep rising, tax audits short of targets Greece’s unpaid taxes rose by €873m in May at a slightly accelerating pace compared to the €763m recorded in April, according to Macropolis. Following May’s performance, the year to date figure of new unpaid tax obligations stands at €5.2bn, which corresponds to an average monthly new tax debt of €1.04bn. Including legacy debt the outstanding cumulative tax debt stood at €66.37bn at the end of May from €65.97bn at the end of April. This slower increase in cumulative tax debt is reflecting also payments against ‘old’ debt, which amounted to €852m, close to the target of €1bn to be reached by the end of June. By contrast, the second target of collecting 16% of new tax debt by the end of June is not likely to be met, the rate was at 11.4% by the end of May. The outcome of tax audits on high wealth individuals showed collected taxes at 40.5% of total taxes due, underperforming the full year target set at 50%. On tax audits and collections of large corporates, the data unveiled that the year to date collection rate stood at 32.4%, which significantly falls short of the full year target of 65%. Collected taxes from temporary audits correspond to 73.9% of total, the only audit category where it beats the target. Greece also to revoke cuts for police and armed forces Faced with a minor revolt within the coalition, Alternate Finance Minister Christos Staikouras promised yesterday to revoke cuts not only for judges following the court order, but also for police and armed forces staff, Kathimerini reports. Staikouras did not 76

specify the size of the sum that would be required, noting that the ruling ordering the revocation of salary cuts for police and armed forces staff was taken this year and so has not been budgeted for. Sources indicated, however, that some €650m will be necessary. This gap is likely to grow as civil servants from other sectors have also been vindicated in court while others are preparing appeals, warns the article. Hospital doctors are already planning legal action against cuts to their incomes. The government is also preparing a tax relief package to offset the impact of years of austerity, according to a top-ranking Finance Ministry official who said the reforms would be enforced from 2015 onward and would not involve Athens reneging on pledges to the troika. Existing levies set to be revised include a special tax on heating fuel and a unified property tax, the official said. Catalan independence progress report In a preview of yesterday’s visit of the new King of Spain Felipe VI to Catalonia, Bloomberg makes two observations: that according to polls support for independence is currently higher in Catalonia than in Scotland, and that Prime Minister Mariano Rajoy is losing the independence debate on the streets of Catalonia. The reality of the situation is perhaps more complex. Rajoy refuses to negotiate with Mas unless the latter gives up his plans for an independence referendum, and Mas might choose to hold early regional elections instead, on which more below. An early election in November would be unambiguously legal unlike a referendum, but it would be “plebiscitary” as the election campaign would be single-issue on independence. The incoming parliament is likely to have an independentist majority with an explicit mandate. Seen from outside, the confusion on the Catalan side appears substantial. At the proclamation of King Felipe last week Catalans and Bask Premiers Artur Mas and Íñigo Urkully were the only ones of 17 regional presidents in attendance to not clap at the end of the event. But then on Monday Artur Mas said on Catalunya Ràdio that the new king should be given “one, two or three chances if necessary”, reports El Mundo. The King responded in kind by making a bilingual speech during his visit to Girona yesterday, reports La Vanguardia. At the same time there is increasingly intense rumour around the possibility that CiU might break up. As we have mentioned on occasion, CiU is a coalition of two parties which have never contested an election separately in 40 years, Convergència led by Artur Mas and its junior partner Unió led by Josep Antoni Duran i Lleida. Unió and in particular Duran are know not to be in favour of independence, and lately it has been rumoured (with little evidence) that Duran might resign his positions, take Unió out of CiU or form a separate party. In this context, the political “barometer” commissioned by El Periódico from pollster GESOP addresses the question of how Catalan voters might respond to a breakup of CiU. The result indicates that Convergència on its own might get as many seats as CiU together, and that Unió would get under 5% of the vote. Only about 40% of people believe CiU would split, about the same percentage that consider it a positive development. The 100-strong Catalan parliament would be extremely fragmented and have an independence supporting majority, with left republicans ERC leading with 40 seats, CiU/Convergència dropping from 50 to 30 seats (less possibly 6 if Unió ran separately from Convergència), 77

Valls' government in reaction mode Cecile Cornudet writes in Les Echos that though Manuel Valls would like to be in the offensive his government finds itself in reaction mode: latest unemployment figures show a continued rise of 24800 more registered in May; in the Assembly, socialist rebels want to weigh on the amended budget; the Assembly adopted a tourism tax increase, which some in the government oppose; Clash also in the Senate over the territorial reforms; while festival artists continue their protest. The government seems to find it difficult to keep up a positive spin, pushing forward Arnauld Montebourg's Alstrom solution and Segolene Royal's ban on plastic bags. Valls agenda is determined by projects of his predecessor and delicate negotiation rounds with the trade unions, while dreaming of more liberty to set the agenda rather than to be determined by it. Maybe in autumn, a close adviser yearns. Macroprudential policy in action – or rather inaction This story is off our reservation, but interesting in as much as it shows macroprudential policy in action, or rather in inaction, as some commentators suggested. The Bank of England imposed a tightening of mortgage lending rules to ensure that the proportion of mortgages with income multiples of 4.5 should not exceed 15%. The Wall Street Journal makes the point that the 15% limit was greater than it was in the past, reflecting a situation in which rising house prices decoupled from incomes, and led to a build-in in personal debt. More measures are possible. It is too early to pass judgement on the macroprudential policy experiment, but in this case the number was clearly picked so as not to cause any ripples, as it won’t have much effect on banks’ lending practices. One should not expect macroprudential policy to prick bubbles. Towards more debt restructuring Ralph Atkins has a discussion on the likely increase in debt restructurings in Europe in view of the €890m planned bail-in of bondholders in Hypo-Alpe Adria of Austria. He writes that debt restructurings could become more common in Europe not just because of the high levels of debt, but also because of the low level of inflation, and the ECB’s reluctance to pursue QE. More restructurings should lead to higher yields, but there is no sign of that happening.

Eurozone Financial Data

10y spreads

Previous This Yesterday day Morning France 0.340 0.336 0.341 Italy 1.447 1.497 1.490 Spain 1.343 1.386 1.393 Portugal 2.154 2.218 2.231 Greece 4.519 4.598 4.68 Ireland 1.077 1.103 1.130 Belgium 0.453 0.456 0.469 Bund Yield 1.322 1.263 1.27 78

exchange rates This Previous morning Dollar 1.361 1.3632

Yen 138.620 138.67

Pound 0.801 0.8024

Swiss Franc 1.216 1.2167

ZC Inflation Swaps previous last close

1 yr 0.74 0.74

2 yr 0.85 0.85

5 yr 1.22 1.22

10 yr 1.65 1.65

Eonia

25-Jun-14 0.04

24-Jun-14 0.04

23-Jun-14 0.03

20-Jun-14 0.03

OIS yield curve 1W 0.056 15M 0.029 2W 0.053 18M 0.035 3W 0.054 21M 0.060 1M 0.062 2Y 0.070 2M 0.074 3Y 0.148 3M 0.077 4Y 0.251 4M 0.075 5Y 0.370 5M 0.073 6Y 0.534 6M 0.071 7Y 0.703 7M 0.069 8Y 0.875 8M 0.067 9Y 1.021 9M 0.066 10Y 1.159 10M 0.051 15Y 1.667 11M 0.065 20Y 1.896 1Y 0.065 30Y 2.029

Euribor-OIS Spread 79

previous last close

1 Week -0.600 0

1 Month 3.586 2.086

3 Months 11.471 9.871

1 Year 39.200 37.6

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-06- 27.html?cHash=302319b303df75c9644b7575a92cea6d

Jeremy Warner Jeremy Warner, assistant editor of The Daily Telegraph, is one of Britain's leading business and economics commentators. He is @telegraphwarner on Twitter. Subscribe to the City Briefing e-mail.

The "Junckernaut" is driving Britain to inevitable separation By Jeremy WarnerEconomicsLast updated: June 26th, 2014

Master of the one-liner: Jean-Claude Juncker Britain’s marital breakdown with much of the rest of the European Union is fast moving beyond the point of no return, with all other member states bar Hungary expected publicly to snub David Cameron at the Ypres summit by appointing Jean-Claude Juncker as president of the European Commission. This should not, however, be seen as a disaster, but rather as an opportunity to negotiate something that has long been inevitable – a new relationship with Europe, which is both detached, but with some kind of continued voice in the affairs of the single European market. Unlike meaningful reform, which is a lost cause, this is an achievable goal, because few in Europe want to see Britain leave the EU entirely.

But first, Mr Juncker. Few people outside Luxembourg and Europe’s political elites had ever heard of him before he was unexpectedly canonised as the European parliament’s candidate of choice, and we know that hardly any heads of government genuinely think him the right man for the job. Even his own countrymen believe him ill-suited. A senior Luxembourg lawyer quoted – anonymously – in the Financial Times this week said he would make a very poor commission president. “He’s a bad organiser, he’s a bad manager, he’s too political. He’s not the kind of guy who likes heading a bunch of technocrats." He does, however, have a talent for one liners, as in most famously, “when the going gets tough, you have to lie”. A studied practitioner of sordid backroom deals, secret trade-offs and deceits, Mr Juncker is the living embodiment of the EU’s crisis of legitimacy. Worse still for an increasingly isolated UK, he has a particular disdain for all things British. Nor is this down merely to David Cameron’s very vocal opposition to his appointment. He’s got form on this front. Nothing must be allowed to stand in the way of the “junckernaut” of ever closer union, is his modus operandi, least of all Anglo Saxon obstructionism. His arrogance in this regard is quite breath taking, given Britain’s position as the Commission’s second biggest source of funds. You might have thought this would command some say in the matter, but no. To Mr Juncker, the wishes of the nation state are subsidiary to supposed collective European destiny, even though it is national governments who are his paymasters. Mr Juncker’s only redeeming feature, as far as I can see, is that he likes a drink, an indulgence which oddly lumps him in with Winston Churchill and Nigel Farage, and makes you think that he cannot be quite as bad as made out. In any case, it is impossible to avoid the conclusion that this is an appointment made more for reasons of spite than the spirit of pragmatic compromise which is meant to instruct European affairs. It is British opposition to Mr Juncker which seems to have solidified support behind him. Once a relationship reaches such an impasse, it becomes obvious that it is basically over. We are already at the separate bedrooms stage; moving out of the shared home altogether cannot be far behind. It is vital, however, that in so doing, total estrangement is avoided. Britain needs a different relationship with the EU, not the painful acrimony of the divorce courts. From the moment Europe decided to adopt a single currency, and thereby set in train a long, drawn-out process of federalisation, it was always inevitable that the UK would one day want to unhitch its wagon. The Eurozone crisis, and the response to it, has accelerated this alienation. Many of the things deemed necessary to save the euro have nothing to do with Britain, and cannot be allowed to govern her affairs. Britain is widely depicted on the Continent as a destructive force in Europe, which like a petulant child, stamps its feet and threatens to block all attempts at progress. You can readily see why some would think that way. At a critical moment in the fight to save the euro, Britain threatened use of its veto against the mooted fiscal pact in order to gain some concession judged so important to British interests that I have plain forgotten what it was. Nicolas Sarkozy was so incensed that he deliberately blinded Mr Cameron at the conclusion of the summit. They think we should compromise to help them; much of Britain thinks it is them who should be accommodating us. As the basis for a strong relationship, it's hopeless. 82

Yet getting out entirely doesn’t strike me as either a wise or necessary approach to the developing standoff in relations. As I’ve written before, I increasingly struggle to see the economic benefits to Britain of the EU, but nor do I see much benefit in leaving, particularly if like Britain, you see your future as an overtly international one. It’s a strange kind of internationalism that rejects the international organisation on its own doorstep. Few business people I talk to are overtly in favour of leaving, though admittedly, a minority are. On the whole, however, they worry about replacing the devil they know status quo with a potentially high risk leap in the dark. Jacques Delors, who whatever you might think of him remains one of the few leaders of any authority and vision to have emerged from the European quagmire, has suggested a possible way out for Britain – a sort of amicable divorce, but with extensive child visiting rights. He’s called it “privileged partnership”, with apparent access to the single market and some say in its operation. For some eurosceptics, this will not be sufficient, for it would require agreement to the four freedoms: free movement of goods, services, labour and capital. For many, national sovereignty means nothing without control of the nation’s borders. Immigration is what fires most people up about Europe; other complaints are for obsessives only. Yet from a purely economic perspective, this looks like a good and workable solution. For the rest of Europe, the single currency is driving a process of integration which must ultimately require some form of fiscal and political union. It’s still a long way off, but it is coming, and inevitably, it places Britain in a completely different, non participant role. Juncker makes no difference to the substance of this divergence, which is already in the stars, but his appointment might accelerate its realisation. Tags: Brexit, divorce, european union, Jacque Delors, Jean-Claude Juncker, separation http://blogs.telegraph.co.uk/finance/jeremywarner/100027542/the-junckernaut-is- driving-britain-to-inevitable-separation/

Catalans Trump Scots With V-for- Victory as Rajoy Shuns Debate By Esteban Duarte - Jun 25, 2014 Spanish Prime Minister Mariano Rajoyis losing the independence debate on the streets of Catalonia. Support for secession in the country’s biggest regional economy has been above 45 percent for the past year compared with 28 percent when the premier took office in 2011, according to regional government pollster Centre d’Estudis d’Opinio. The premier this week ruled out talks with the Catalan government unless it withdraws the referendum planned for Nov. 9. Felipe VI makes his first visit to Catalonia as king today after making an indirect appeal to the region to remain part of Spain in his proclamation speech last week. A fluent Catalan speaker, Felipe is trying to hold onto a region that accounts for 10 percent of Spain’s tax revenue and a quarter of its exports. That’s not an easy task, with momentum against the central government, according to Jose Ramon Montero, a former deputy managing director of Spain’s government-run pollster. “The pro-independence campaign is winning,” he said. As Scotland prepares for a Sept. 18 vote that could end the 307-year-old U.K., momentum is building in Catalonia for a breakup of Spain. And while U.K. Prime David Cameron is campaigning to keep Britain united, his Spanish counterpart refuses to engage -- either with regional President Artur Mas in Barcelona or with Catalan voters. Rajoy says the independence vote Mas plans won’t take place because it’s unconstitutional. ‘Burning Bridges’ “The government is burning all its bridges,” said Jose Ignacio Torreblanca, head of the Madrid office of the European Council on Foreign Relations. “If the strategy fails, you could see civil disobedience on one side, and then suspension of the region’s powers and eventually jail for those that called the illegal referendum.” Mas is among those who will attend a dinner with the king tonight as Rajoy tries to force the Catalan leader to back down from his referendum plans with the offer of negotiations. “If now Mr. Mas decides against holding that referendum which he knows is illegal, because everyone has told him so, then I am prepared to listen to him,” Rajoy said June 23 in televised comments from Gdansk, Poland. “If he wants to force the rest of us to do what he wants, that’s very difficult.” The political situation may get worse for Rajoy after Catalan national day on Sept. 11. Last year, more a than a million people demonstrated for independence and support for secession reached a record 49 percent the following month.

Scottish Referendum This year the holiday marks the start of the run-in to the referendum date. Nationalists plan a protest where two of Barcelona’s main boulevards cross to form a V, standing both for Victory and Vote, according to its website. Seven days later, Scotland will hold its own independence referendum, potentially adding further momentum to the Catalans’ cause. “Depending on what happens in Scotland, the situation in Catalonia could be more closely monitored,” said Francois Lavier, a fixed income fund manager who helps invest 14.6 billion euros at Lazard Freres Gestion in Paris. “There are plenty of questions which remain open: what about the currency? what about the debt? and the potential re-denomination risk.” Mas’s campaign is backed up on the streets by activist groups including the Catalan National Assembly which has more than 32,000 paying members and is endorsed by four political parties. Those groups got 56 percent of votes in the region during the European Parliament election last month. Dwindling Support The surge in support for independence since Rajoy took office in 2011 is also reflected in polls by companies including Metroscopia. The number of Catalans in favor of the status quo dropped to 23 percent from 30 percent at the start of his term, according to Catalan pollster’s research. In Scotland, a survey published this month by TNS showed 30 percent in favor of independence with 42 percent opposed. Rajoy’s reliance on the 1978 constitution contrasts with U.K. Prime Minister David Cameron’s battle to convince Scots to remain part of the U.K. The “Better Together” campaign is headed by a one-time political opponent of Cameron’s, former Labour Chancellor Alistair Darling, draws on a panel of 50 academics, economists, central bankers and investors; and just landed a 1 million-pound ($1.7 million) donation from J.K. Rowling, the creator of Harry Potter. “You have to explain whether the other side’s arguments are true, viable or decent as the ‘Better Together’ campaign is trying to do,” said Felix Ovejero, a political philosophy professor at Barcelona University, and a founder of the Ciudadanos, a unionist party. “It would good to have a proper political debate.” Rajoy’s strategy suggests he’s focused on the more immediate concerns, said Torreblanca, who is also a professor of politics at UNED college in Madrid. “The government is only looking as far as the local and regional elections” due next year, he said. “In the medium term, that’s a risky strategy.” To contact the reporter on this story: Esteban Duarte in Madrid at [email protected] To contact the editors responsible for this story: Alan Crawford at [email protected] Sills http://www.bloomberg.com/news/2014-06-25/catalans-trump-scots-with-v-for-victory- as-rajoy-shuns-debate.html

ft.com/markets MARKETS INSIGHT June 26, 2014 7:58 am Europe rethinks how to cure its debt hangover By Ralph Atkins in London Austria part of trend that could make restructurings more common A government reneges on state guarantees. Losses are inflicted on bond holders. Other investors worry they might be next. This was not Argentina but Austria, one of Europe’s most prosperous and conservative democracies. More ON THIS TOPIC// Austria rules out Hypo insolvency/ Austria warns costs of bank bail-out rising/ Chairman of Austria’s Hypo bank resigns/ Austria budgets €1bn aid for Hypo bank MARKETS INSIGHT/ Investors manic for ‘disrupter’ stocks/ Don’t bank on a comfortable rate ride/ Iraq crisis puts oil markets on alert/ Beware central banks’ share- buying sprees Plans announced this month to wind down Hypo Alpe Adria, a midsized lender from Carinthia, attracted little international attention. But they could have significance beyond Austria’s borders. They offer an illustration – or warning – of how Europe will address high levels of indebtedness which continue to blight economic growth prospects. Rather than taxpayers footing a bigger bill, Vienna plans legislation allowing it to “bail- in” €890m of subordinated debt which had been guaranteed by the state of Carinthia. While Michael Spindelegger, Austria’s finance minister, played down the broader implications, investors in Europe’s weaker banks were put on notice: you could be on the frontline in the next bank rescue. Austria’s actions are noteworthy not just because of Vienna’s apparent capriciousness – rating agencies warn of downgrades for other Austrian banks. The Hypo case is part of a trend to put in place practices and mechanisms that could make debt restructurings more commonplace in Europe – for public as well as private sector debt. Reckless credit splurges In Argentina, debt restructuring has just become a lot more complicated after the government lost a lengthy legal conflict in the US with “holdout” creditors. The fallout could affect other sovereign debt workouts. But a rethink, coincidentally unveiled this week, by the International Monetary Fund of its approach to country bailouts in the light of the eurozone crisis could have the opposite effect, giving it more flexibility when governments get into trouble. FT Video Are markets wrong on Europe?

May 2014: If you believe the markets, the eurozone sovereign debt crisis is over. But, says Roger Bootle, author of ‘The Trouble with Europe’, markets have misread Europe in the past. He tells John Authers how the EU needs to change to fix Europe’s fiscal problems. European policy makers have long recognised the continent’s debt problem. The euro’s launch in 1999 encouraged reckless credit splurges, especially in countries on its periphery – such as Greece, Ireland and Spain. When the eurozone crisis erupted in 2010, however, the idea of imposing losses on creditors was strongly resisted. Partly, it was pride. Jean-Claude Trichet, then European Central Bank president, had witnessed the consequences of debt restructurings when he chaired the Paris Club of international creditors in the late 1980s. For him, unblemished creditworthiness was part of being an advanced European economy. But there were also real fears of contagion. The ECB blocked Ireland from imposing losses on senior bond holders of its bust banks to protect the wider European Union banking system. There were worries that a premature Greek default would trigger an even bigger financial crisis. The IMF amended its rules so it could continue to support countries if there was a high risk of “international systemic spillovers” even when it feared debt levels were not sustainable. Four years on, the landscape has changed. Fears of a eurozone collapse have disappeared and Greece’s debt restructuring in 2012 showed contagion effects were manageable. “Collective action clauses”, which make it easier to bind recalcitrant investors into a restructuring, have become standard in new eurozone government bonds – and should help avoid Argentine-type problems. This week’s IMF paper proposed revoking the 2010 amendment and broadening the range of options for struggling countries to include earlier debt maturing extensions, or “reprofiling”, as a softer option. Taxpayers protected When it comes to bank rescues, Austria’s Hypo case was not as wilful as it might seem. Rather, it fitted with the principle of minimising taxpayers’ involvement when banks go wrong that is written into Europe’s post-crisis regulatory regime. It is “pushing in the same direction” as the IMF initiative, says Alistair Wilson, credit analyst at Moody’s. “It is all about trying to find more effective resolution when borrowers lose access to markets or are unable to service debt.” Europe’s approach is not out of line with the rest of the world; there is global agreement on tackling banks “too big to fail”. But debt restructurings may become more of a Europe story not just because of its high levels of indebtedness. The ECB is less inclined than US or UK counterparts to use inflationary “quantitative easing” to erase problems left over from the post-2007 crises. More frequent restructurings could see investors demanding higher yields. So far there is scant sign of that happening. As everywhere else, markets in Europe have rallied as low official interest rates have driven investors into riskier assets. But higher borrowing costs are not inevitable if a more realistic approach to debt problems strengthens economies – and there is method in politicians’ actions. http://www.ft.com/intl/cms/s/0/da7aee7c-fc80-11e3-98b8- 00144feab7de.html#axzz35pP3EJFd 87

Venezuelan Zara Binge Gives New Meaning to Fast Fashion By Rodrigo Orihuela and Corina Pons - Jun 27, 2014 On the rare day that Zara had clothing to sell in Venezuela, the fast fashion was disappearing even more quickly than usual.

Photographer: Corina Pons/Bloomberg Photographer: Corina Pons/Bloomberg People wait in line outside a Zara store at the Sambil shopping People wait in line to get into a Bershka store at the Sambil mall in Caracas. shopping mall in Caraca About 300 people lined up at midday outside a Zara store in the Sambil shopping mall in Caracas last week, seeking clothing as the country’s currency controls have emptied stores of imports. Shoppers waited their turn after picking a number under the eye of security guards, who controlled access to the shop. The chain was able to dress up mannequins and restart business after the government granted access to cash at a preferential rate to the franchise operator for Inditex SA (ITX) in the Latin American country. That translates into discounts of as much as 85 percent for consumers. As nobody knows how long the shelves will remain stocked, shoppers flocked to the shops, including Celestina Aponte, a 23-year-old lawyer who called in sick to get a chance to spruce up her wardrobe at prices a fraction of those offered by street vendors. “I haven’t bought clothes yet this year as everything is too expensive,” Aponte said, having spent 10,000 bolivars, the equivalent of about $137 at the black market rate, on blouses and pants, which translates into $943 at the preferential exchange rate obtained from the government. “You need to spend hours in line to buy milk, corn flour and now pants.” Consumer Shortages The situation showcases the hardships of doing business inVenezuela, where a shambolic economy has led to shortages in everything from dollars to toilet paper and medicines as the country grapples with 61 percent annual inflation, the highest in the world. 88

Phoenix World Trade, the Panama-based company that runs the franchise for Zara- owner Inditex SA in Venezuela, had been unable to import clothing in the past year because it couldn’t acquire foreign currency from the government to pay its suppliers. Inditex declined to comment for this story, directing all questions to closely held Phoenix World Trade, which got the franchise in 2007. Inditex shares traded 0.5 percent higher at 112.95 euros at 9:01 a.m. in Madrid, bringing their gain over the past year to 17 percent. The franchise operator recently gained access to the country’s Sicad I currency market, which offers dollars at a preferential rate, after months of talks with the government, Phoenix World President Camilo Ibrahim said by e-mail. That rate was last 10.6 bolivars per dollar compared with the black market rate of about 73 bolivars. After the company agreed to limit its profit margins by allowing a government agency review its pricing and costs, Phoenix has gradually started reopening some stores. Empty Stores “The problem started because there wasn’t a legal and efficient foreign exchange system that allowed us to pay our suppliers,” Ibrahim said by e-mail. “Because of this, in mid- 2012 we stopped being able to bring products to the country and this led to stores being empty in late 2013 and most of 2014.” Venezuela has maintained strict currency controls since 2003 and uses an official rate of 6.3 bolivars per dollar for importing essential items such as staple food products and medicine. The Sicad I rate is for “priority” imports such as car parts, chemicals, school supplies -- and now fashion clothing. In March, the government introduced a second alternative market known as Sicad II that sells dollars for authorized imports of non-essential goods at about 50 bolivars per dollar. Faltering Economy Payments to food importers and drug companies started to slow last year after the government devalued and reduced the supply of dollars to the private sector, with some Venezuelans crossing the border to Colombia in search of medicine. In the past year, the bolivar has lost 56 percent of its value on the black market that is used as a reference by many stores to set prices. Venezuela’s finance ministry did not immediately respond to telephone messages and e- mails sent yesterday seeking comment on the government’s currency allocation priorities. The clothing and footwear sectors received $370 million during the first four months of the year at the Sicad I rate, according to Henkel Garcia, director of Caracas-based consultancy Econometrica. Disappearing Clothes “Venezuela’s government is giving the same priority to clothing and footwear as the health-care sector,” Garcia said.“People are waiting in lines because it’s cheap, and they all know that the clothes are going to disappear.”

Phoenix runs 25 stores in Venezuela under Inditex brands including Zara, Pull & Bear and Bershka. Only three Latin American countries have more stores under the Spanish company’s formats. “Merchandise at those good prices will probably be sold out in two or three weeks,” said Alfredo Cohen, president of the national mall association. He said he expects stores will be switched to the Sicad IIexchange rate, which is less preferential, and then “mall activity will return to a normal situation.” The Bershka store in Caracas had better prices than in local street markets, according to Carolina Perez, 21, who was shopping with her two-year-old daughter. “It was good to buy here today as I could buy three blouses for 1,000 bolivars when it’s only possible with that money to buy one from street vendors in downtown Caracas,” she said. “It was a pity I could not find any jeans.” Shoppers, meanwhile, are taking advantage of the offerings while they last. Gimi Lata, a 31-year-old washing machine repairman, showed up at 6 a.m. outside a Caracas Zara store with two of his brothers, his wife and their nine-month-old baby. They all showed up together because the store limits sales to six items per person, Lata said. Zoila Gutierrez, a 42-year-old homemaker, was one of the shoppers in line behind about 300 people outside the Zara store in the same Sambil mall last week. She said if only they’d hand out 200 more numbers, maybe she’d get in. “We are ready to spend all day to take advantage of this opportunity,” Gutierrez said. To contact the reporters on this story: Rodrigo Orihuela in Madrid at [email protected]; Corina Pons in Caracas at [email protected] To contact the editors responsible for this story: Celeste Perri at [email protected] Mulier, Nathan Crooks, David Risser

Italian Debt Swells to Rival Germany as Bond Yields Slide By Lorenzo Totaro - Jun 27, 2014 As Italy’s borrowing costs fall to new lows, its debt is rising to the most ever. The country owed 5 percent more in April compared with a year earlier, with debt reaching 2.15 trillion euros ($2.9 trillion), Bank of Italy figures show. That matches the outstanding borrowing of Germany, the largest economy in Europe and the most of any country on the continent, at the end of last year, according statistics office Eurostat. While Germany is scheduled to grow 2 percent this year, Italy will expand 0.3 percent in 2014, according to a Bloomberg survey. To ensure its debt is sustainable, Prime Minister Matteo Renzi is under pressure to push through spending cuts and foster growth in an economy burdened by the threat of deflation and the highest jobless rate on record. “In our forecasts Italian debt will overtake Germany by the end of the year,” said Raffaella Tenconi, an economist at Bank of America Merrill Lynch in London. “It is particularly important that the government moves ahead with the promised reforms to firm the sovereign credit rating and strengthen further investors’ appetite for Italian assets.” In the meantime, the repayment of arrears to state suppliers, the contributions to the euro-area rescue funds, lower tax revenue due to the effects of the record-long economic slump and financial servicing costs keep adding to Italy’s debt load. With the European Central Bank backstopping the euro over the past two years, the yield on 10-year Italian bonds meanwhile fell to as low as 2.69 percent this month, narrowing the premium over equivalent German bunds to the least in three years. Italy’s 10-year yield was little changed at 2.84 percent as of 8:54 a.m. Rome time. Pace Accelerated In the first four months of this year, Italy’s debt rose by 77 billion euros, almost as much as the total 79.8 billion euros it grew in 2013, according to the the country’s central bank. The ECB on June 5 unveiled an unprecedented round of measures to help its record-low interest rates feed through to the economy. They included cutting its deposit rate to minus 0.1 percent, which made the ECB the first major central bank to take one of its main rates negative. ECB actions will boost Italy GDP in coming years, Bank of Italy Deputy Director General Fabio Panetta said. “Based only on the effects recorded so far on currency exchange and market rates, we can estimate a cumulative stimulus to output in the three years 2014 to 2016 of about half a percentage point,” Panetta said at a June 19 event in Rome.

Renzi’s government is seeking a return to growth after a recession that lasted more than two years. The Italian economy, the euro region’s third-biggest, contracted 0.1 percent in the first quarter before industrial production resumed increasing in April, national statistics agency Istat said on June 10. Rebooted Rally The weak growth prospects were cited by Standard & Poor’s when it kept a negative outlook in its June 6 review of Italy’s credit rating. S&P said the ECB “helped reduce financing tensions for many euro zone members, including Italy.” Italian borrowing costs fell to record lows this week at sales of April 2016 zero-coupon notes and six-month bills as the prospect of continued accommodative monetary policy from the ECB rebooted a rally in euro-region bonds. The Treasury in Rome plans to auction as much as 8 billion euros of debt maturing between 2019 and 2024 today. This year, Italy foresees increasing its debt ratio to 134.9 percent of gross domestic product from 132.6 percent in 2013, relying on the sale of stakes in the nation’s postal office and air traffic controller to prevent a further increase, according to the government’s economic and financial plan passed in April. Debt is projected to fall to 125.1 percent of GDP by 2017. Ambitious Forecast? The government is counting on growth of 0.8 percent this year to help meet its budget goals. That forecast contrasts with business lobby Confindustria, which cut its estimates for GDP in 2014 to 0.2 percent from an increase of 0.7 percent previously. Italy’s “fiscal policy needs to strike a delicate balance between setting the debt ratio on a downward path while avoiding excessive tightening that derails the fragile recovery,” the International Monetary Fund said in a report this month. “More needs to be done to bring down the high level of public debt and strengthen the resilience of public finances.” The IMF also said in the June 17 report the government’s “privatization efforts should be completed quickly.” Finance Minister Pier Carlo Padoan said last week that he shared the IMF’s call to cut the debt-to-GDP ratio and that the government’s privatization plan is “ambitious.” To contact the reporter on this story: Lorenzo Totaro in Rome at [email protected] To contact the editors responsible for this story: Heather Harris at [email protected] Kevin Costelloe, Rodney Jefferson http://www.bloomberg.com/news/2014-06-26/italian-debt-swells-to-rival-germany-as- bonds-rally-euro-credit.html

Top 10 Business Schools worldwide

Students are basing their research for business school on their network of contacts, skills and knowledge to acquire and the brand value associated to it. Here is the Top 10 of Business School Worldwide. Stanford Business School In first position comes the Stanford Graduate School of Business (also known as Stanford Business School, Stanford GSB, or The GSB). Apart from MBA and Ph.D, The GSB offers other programs in Earth Sciences, Education, Engineering, Law and Medicine. It is ranked number 1 business school in the United States according to U.S. News & World Report. Harvard Business School Harvard holds the top spot for the past two years now. This private business school located in Boston also known as Harvard Business School (HBS) is categorized as one of the most well-known schools offering the best full-time MBA program, doctoral programs, and other executive education programs. The establishment now counts 1,917 students in MBA and 100 in Ph.D. Booth School of Business The University of Chicago Booth School of Business formerly known as the University of Chicago Graduate School of Business comes in line with its Executive MBA program and is the first to initiate a Ph.D. program in business. The school is conducting research in the fields of finance, economics, quantitative marketing research, and accounting. It is ranked Chicago Booth first globally according to Economist. Wharton School of the University of Pennsylvania Wharton School is located in the place where the Declaration of Independence and the United States Constitution were drafted and signed. Established in 1881, students from all around the world are rushing to integrate it. It counts 2,306 undergraduate and 1,671 postgraduates.

London Business School (LBS) The next one is located in London, the LBS. Having motto to develop insights and leaders that have impact, this Public Business School promoted and is still continuing promoting legends in business world. An executive MBA degree and Executive Education programs has been launched in Dubai since 2006. IESE Business School On the next list comes IESE Business School or the Instituto de Estudios Superiores de la Empresa in its original language. Campusing in Barcelona, Madrid, Munich, Sao Paulo and New York City, the institute offers Master of Business Administration (MBA), Executive MBA and Executive Education programs ranked and recommended from all around the world. INSEAD With different campuses scattering in Europe, Singapore, Asia and the Middle East, INSEAD Business School remains one of the most recommended in terms of programs. It has reciprocal agreements with Harvard Business School, Stanford Graduate School of Business and Kellogg School of Management. HEC Paris The « Ecole des Hautes Etudes Commerciales de Paris » makes French and European pride. The institution reaches the first position in Europe and France and among the top 10 in the world. It is considered as being one of the most prominent business schools in the world. University of California, Berkeley “Let there be light”, the University Motto makes its fame all over the world. The public University of California, Berkeley is the oldest institution in the UC system. It grants its students with approximately 350 undergraduate and graduate degree programs. Columbia Business School The private institution is a world-leading business school providing its students knowledge and leadership across the disciplines. Columbia Business School keeps its reputation title in national rankings until now. http://toptipsnews.com/top-10-business-schools-worldwide/?utm_source=t- bloomberg&utm_medium=referral

Daily Morning Newsbriefing June 26, 2014 The unhealthy obsession with Juncker Fredrik Reinfeldt and Mark Rutte announced yesterday that they would both support Jean-Claude Juncker, the Wall Street Journal reports. The vote on the European Commission presidency is scheduled to take place Friday, on the second day of the European Council. Herman van Rompuy will propose Juncker. There will be no other candidate. As Matteo Renzi has now dropped the demand for a change in the rules, Angela Merkel is not going out of her way to insist that the existing framework is, in fact, quite flexible to meet the demand for growth. Any earnest fiscal discussion is thus postponed until the moment when policy is implemented. Renzi will now support Juncker. Juncker’s pending nomination has Britain’s establishment in a frenzy – though the news cycle there is currently interrupted by the latest developments in a phone hacking scandal. We cannot recall a situation in which an entire political class, the media and intellectuals have misjudged a European issue so profoundly for such a long period. But reading the following tweet, even we were stunned: Charles Grant ?@CER_Grant “@JunckerEU: 10 Downing St is thinking of threatening to recommend a NO vote in referendum, to push #EU towards real reform @CER_London” Interestingly, an FT poll suggests that a 2-1 majority of the British support Cameron’s tactics, so his “diplomacy” may actually work for him in a narrow sense. It is hard to see a happy ending to this. If Downing Street goes ahead with this strategy, Britain would become even more isolated. Success in EU politics requires coalition building. None of the others want Brexit, but nobody will go out of their way to stop it if confronted with such tactics – not even Angela Merkel, who really wants Britain to stay in the EU. There is a German saying – one that Helmut Schmidt famously used when the FDP was about to leave his coalition in 1982: “Reisende soll man nicht aufhalten.” You should not delay a traveller. It feels similar now. Scandal in Spain over MEPs supplementary pension fund InfoLibre reports that Willy Meyer, long-time MEP and leader of the Spanish contingent in the GUE/NGL parliamentary group, has resigned and will not take his seat as a result of revelations that he participated in a private pension fund for MEPs which uses a Luxembourg vehicle to pay reduced taxes. The existence of such investment vehicles (called by the acronym Sicav), has been the object of controversy in Spain for years, with the United Left party IU being a prominent opponent of the practice in the Spanish parliament.

Other prominent MEPs with funds in the pension plan include the lead candidates of the PP and PSOE in the recent European elections, Miguel Áreas Cañete and Elena Valenciano. Also Rosa Díez, a former PSOE MEP and leader of up-and-coming party UPyD, has come under fire for the inconsistency between her participation in the fund and the reformist agenda of her political party. One can wonder why the scandal erupts now, as the existence of this fund has been controversial at the European level for many years, and even a partial list of participant has been known since 2009 – on which Open Europe reported back then. Magdalena Álvarez steps down from the European Investment Bank Protesting her innocence and saying she resigns under pressure and for the damage to the image of the EIB and Spain, Magdalena Álvarez has stepped down as EIB vicepresident, reports El Mundo. Álvarez told a press conference that Spanish economy minister Luis de Guindos personally reassured her months ago and told her to continue with her work, a position that ostensibly changed when her indictment became firm. She also compared herself to Christine Lagarde, who is under investigation in a corruption case in France, but not indicted. By pre-empting a disciplinary procedure of the EIB, Álvarez keeps a severance package and a sizeable lifetime pension. Greek coalition leaders to head off series of mini-rebellions In Greece, the coalition’s leadership was yesterday seeking to head off a series of potential mini-rebellions by its MPs, Kathimerini reports. Five conservative MPs threatened to vote against an amendment revoking cuts to the income of judges unless similar income reductions are also reversed for police and armed forces employees. The finance ministry submitted an amendment to parliament a day after a court ruled that retroactive cuts to the judges’ pensions were unconstitutional. There are concerns that other rulings could prompt similar reactions by other lawmakers. Another conservative MP called on the government to honour a court ruling issued in May and rehire hundreds of Finance Ministry cleaners who have been put into a mobility scheme for civil servants. Commenting on the case of the cleaners, Administrative Reform Minister Kyriakos Mitsotakis said that rehiring them in the absence of a final decision by the Supreme Court, which is expected in the fall, would challenge the foundations of a mobility scheme which Greece has promised the troika it will enforce. Portugal receives early repayment from banks Three Portuguese banks have returned state funds earlier than expected, providing the state with €2.18bn in extra cash, almost the same amount of the last troika tranche Portugal's government decided to not take, Diario Economico reports. After waiving the last tranche worth €2.6bn the treasury already planned to increase bond auctions, increasing the target from €3.6bn to €6bn-€6.5bn in money raised from private investors. With this unexpected cash from the banks though, the financing plans became slightly simply. Jornal de Negocios notes that BPI, BCP and Banif returned almost 40% of the money they received from the troika funds, €5.4bn they received in total. Industrial rivalry, not Europe, decided the battle for Alstrom The Wall Street Journal wrote a revealing piece about GE's and Siemens' fight over Alstrom which is now putting the government in an awkward position towards Germany. Siemens had expressed its intend to create European champions end of April, when Alstrom was already in talks with GE for months, unknown to the French 96

government. When they found out, they pressed Siemens for a concrete bid and GE to extend the deadline. Siemens bid fell short of anything close to the ambition of a European champion and dragged Mitsubishi into the picture. Alstrom clearly favoured the GE deal, while Siemens stands accused of only wanting to spoil the party and head off competition. The GE deal though leaves the French government in an awkward position: "Having failed to broker a marriage between Alstom and Siemens, the French state—which is set to become Alstom's largest shareholder—is literally going into business with GE and becoming a direct competitor of the German firm." Peter Ramsauer, chairman of the German Parliament's economics committee and a key ally of Chancellor Angela Merkel said the French government, has "put unilateral French interests ahead of European interests." The French government says its intervention ultimately safeguards thousands of jobs as well as Alstom's French identity. Siemens and Alstrom are bitter rivals for some time now, and that European interests were not at the heart of Siemens either seems obvious according to a letter Joe Kaeser sent to his employees. "The implementation of this deal [with GE] will keep two of our competitors busy for years to come," he said in the letter, the WSJ reviewed. "This alone was worth fighting for." He also gloated that Alstom had fallen back into the arms of the French state. "Having the French government as [the] largest shareholder will ensure that any U.S.-style productivity and restructuring measures will be extremely difficult to get done," Kaeser said. Irish house prices rise 10.6% in May Irish house prices rose in May at their fastest rate since before the 2007 property bust, fuelling concerns that a rapid increase will create new problems in Ireland's still troubled housing market, Wall Street Journal reports. Nationwide, residential prices rose 2.3% on the month and were 10.6% higher than in May 2013. Prices rose even faster in the populous Dublin region, and were 22% higher than a year earlier. Analysts say prices are pushed up in an unhealthy market with restrained supply: There are only few new houses built because many building firms were damaged or went bust during the crisis, while existing homeowners are existing homeowners are currently unwilling to sell. High levels of home-loan debt, a legacy of the property bust, mean many households cannot contemplate selling for some time. Not-for Profit organisations warn there is a shortage of social or affordable homes and that homelessness is rising in Dublin. Enda Kenny told lawmakers Wednesday that the shortage of housing in Dublin can only be solved by building more houses, and measures such as removing delays in planning permits will help. Property price gains do however help the banks to cut some of their losses on their mortgage books. German Laender struggle with higher debt The German state might have a budget surplus but the regions struggle with rising debt. In eleven of Germany's 16 regions, the budget situation is currently worse than a year ago. Saxony, Bavaria and Lower Saxony are currently the only three Laender with a surplus; a year ago there were five. The regions spent €6bn more than their revenue income in the first five months this year, increasing the deficit to €1.8bn compared with the same period last year. The reason for this development is increasing spending, Spiegel Online picked up from a Handelsblatt article. For staff, investment and the municipalities, the provinces spent more money on a broad front. Total expenditure

increased by 4%, while revenues were only 2.7 % higher than the same period last year. Only the lower 8.3% interest expenditure prevented an even worse record, the newspaper writes. Also in the German towns and cities, social spending get out of hand. The local umbrella organizations expect an increase in cost in the region around €1.8bn annually. Social spending is the reason why the communes will not achieve a balanced budget for some time. FAZ getting worked up over Italy FAZ reports on the Italy economy with an energy that comes close to its domestic reporting. The paper’s hyperactive Rome correspondent has turned a study on Italy’s fall in global competitiveness into an alarmist new story that clearly intends to scare people of an imminent collapse of the country. While global productive capacity increased by 36% between 2000 and 2013, it decreased in Italy by 25% according to a study by Confindustria, which blames the rise in wages, the high exchange rate of the euro, the credit crunch, and the fall in domestic demand. The author favours the thesis that Italy is not investing enough in strengthening productive capacity. And while the economy burns, the country’s political elites are quarrelling about a change in the fiscal rules. Inflation expectations between Germany and US reach record high The FT picked up on a new record gap in eurozone and US inflation expectations. 10y US breakeven rates were 2.27%, while 10y German inflation expectation are 1.34%. With signs of a US recovery – after a further downwardly revised Q1 – investors are betting heavily on a pick-up in US inflation. Mohamed A. El-Erian has a comment in Bloomberg, in which he forecasts that Mario Draghi will lead the ECB towards additional policy easing in the autumn – comparing the situation to that of the Fed between 2011 and 2013 when it ventured into untested policies, as it is confronted with less than perfect fiscal and financial policies, and continued geopolitical risk. On inflation expectations: These numbers are clearly policy-dependent, and in part self- fulfilling. Also note that the ECB looks at a different data – the 5y 5y forward inflation swaps, which show expectations eerily anchored at precisely the ECB’s target. One the timing of the next decision. We also the ECB acting, but probably not until November or more likely December as the June 5 agreement in the GC has been to wait and see how the recent measures are working. We are not holding our breath. The early indications are that the banks will find ways to use the TLTRO to support sovereign bond purchases. We are not seeing any immediate deterioration in inflation rates, certainly not in core rates as wages grow at lucklustre, but still positive rates. But the recovery will remain sluggish, and pressure for further action will gradually increase. Wolff says don’t waste time on fiscal rules, focus on investment Guntram Wolff says the debate on fiscal rules is counter-productive. He makes three points. The first is there is not sufficient fiscal space in several countries for large-scale stimulus spending. The best governments can do is a reform of the state, and an adjustment in fiscal expenditures from social spending to growth enhancing public goods. The second is an explicit recognition that debt sustainability is hard to achieve when inflation rates are low, and those countries with fiscal headroom should invest in infrastructure, education or R&D. The third is a plea for more investment into European public goods.

Points one and two constitute an ideal first-best scenario, but we do not think it is going to happen for political reasons. Renzi does not have sufficient political capital to undertake such a radical shift. And Germany will not breach its own “debt brake” – a constitutional law after all - for the benefit of third countries. The ECB, meanwhile, has clearly recognised that low inflation is a problem, but it is not clear that the tool they deployed will address the problem. It is going to very hard to pull the eurozone out of its misery by reliance on domestic programmes. Testing Paul de Grauwe’s financial stability hypothesis Orkun Saka, Ana-Maria Fuertes and Elena Kalotychou have been testing Paul de Grauwe financial fragility hypothesis, which says countries in a monetary union are prone to financial contagions. They provide further statistical evidence in support of the theory, and especially in support of the role played by the ECB’s OMT programme. However, the fragility is not gone. One source of potential conflict is the legal uncertainty resulting from the ruling of the German constitutional court. The finding of their study strongly supports the notion of a common backstop. The Return of the Sleepwalkers Dominique Moisi has a thoughtful Project Syndicate column in which he draws parallels between 1914 and 2014. He says the problem no longer arises in Europe itself – the result of the EU’s historic achievement of securing lasting peace. The dangers lies outside. “A jihadist state has emerged in the Middle East. Asian countries have begun creating artificial islands, following China’s example, in the South China Sea, to strengthen their territorial claims there. And Russian President Vladimir Putin is overtly pursuing anachronistic imperial ambitions. These developments should serve as a warning that the world cannot avoid the truth and avert disaster at the same time. “… While 2014 ostensibly has little in common with 1914, it shares one critical feature: the risk that an increasingly complex security and political environment will overwhelm unexceptional leaders. Before they wake up to the risks, the situation could spin out of control.” Eurozone Financial Data 10y spreads

exchange

rates This Previous morning Dollar 1.361 1.3632

Yen 138.620 138.67

Pound 0.801 0.8024

Swiss Franc 1.216 1.2167

ZC Inflation Swaps previous last close

1 yr 0.74 0.74

2 yr 0.85 0.85

5 yr 1.22 1.22

10 yr 1.65 1.65

Eonia

25-Jun-14 0.04

24-Jun-14 0.04

23-Jun-14 0.03

20-Jun-14 0.03

Euribor-OIS Spread previous last close

1 Week -0.600 0

1 Month 3.586 2.086

100

3 Months 11.471 9.871

1 Year 39.200 37.6

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-06- 26.html?cHash=17ba8da841000f85541c4aef58af660d

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EUROPEAN ECONOMY Draghi and the Art of the Feasible

Jun 25, 2014 6:33 AM EDT By Mohamed A. El-Erian European Central Bank President Mario Draghi has already surprised many with bold policy moves to buttress the European economy, but you can expect him to lead the ECB toward an additional set of innovative measures. This will probably happen in the autumn, and Draghi's success will continue to hinge on factors outside his, and his central bank colleagues', control.

Just three weeks ago, Draghi implemented a broad range of unconventional measures aimed at stimulating growth, helping credit-starved companies and curtailing the risk of damaging deflation. But in financial markets where the most tangible links between policy and economic improvement are visible, reception to his moves has been rather muted -- exemplified by a euro that remains stubbornly strong relative to other currencies despite Europe’s economic circumstances. Meanwhile, recent data confirm that the European economy is expanding, but only timidly, and growth is nowhere near what is needed to deal with the severe unemployment and debt problems still challenging the region. Europe has also been weighed down by geopolitics and regional political wrangling. Turmoil in Iraq has added to the upward pressure on oil prices already sent aloft by slow progress in resolving the Ukrainian crisis -- thus serving as an added tax on both European consumers and producers. Meanwhile, the battle over Jean-Claude Juncker’s appointment as the next president of the European Commission has diverted political energy away from other significant economic policy priorities. And with Italy about to

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take over the rotating presidency of the European Union, policy bandwidth will have to expand to deal with renewed debates over what constitutes appropriate government intervention in the economy. Faced with all this, the ECB is likely to again feel compelled to do more to stimulate economic growth even though it is the first to recognize that it is using imperfect tools for that task. The next set of measures -- which will involve greater use of the central bank’s balance sheet to keep interest rates low and improve the flow of credit -- will likely come in the fall because the ECB needs time to complete the design and implementation of policies it has already announced. For the remainder of the year, the ECB will find itself on an experimental path similar, though not identical, to the one that the U.S. Federal Reserve already took between 2011 and 2013. That path forced the Fed to venture ever deeper into unusual policies because others in the U.S. government were either unwilling or unable to step up fully to their responsibilities, even though they had better tools than the Fed at their disposal. The outcome in Europe also will likely be the same as it was in the U.S.: success in avoiding a truly bad economic outcome but frustration in failing to trigger the robust economic liftoff that Europe needs. Albert Einstein is said to have defined insanity as doing the same thing over and over again while expecting different results. While the ECB has clearly not lost its bearings, it is being forced to operate far away from an arena in which the best European economic and financial policy making is taking place. Like other instances in politically shackled Western economies, the ECB has no choice but to operate experimentally and with a heavy hand in order to pursue what is feasible, even if it's not entirely desirable. To contact the writer of this article: Mohamed A. El-Erian at M.El- [email protected]. To contact the editor responsible for this article: Timothy L. O'Brien at [email protected]. http://www.bloombergview.com/articles/2014-06-25/draghi-and-the-art-of-the-feasible

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What's not to like? Photographer: Clive Rose/Getty Images WORLD CUP Lessons From the World Cup

Jun 26, 2014 6:33 AM EDT By Mohamed A. El-Erian Every football fan I meet has been pleasantly surprised by the World Cup’s high level of competition and quality. Exemplified by Costa Rica’s remarkable start, quite a few nontraditional teams that global football brand names once viewed as mere pushovers, even irritations, have done surprisingly well. Meanwhile, some once-mighty teams -- such as England, Italy and Spain -- find themselves out of the competition, unable to make it through a competitive initial stage. Others, such as Argentina, Germany and Portugal, have encountered scrappy squads that gave them a scare, and they now have to take those seemingly weaker competitors more seriously. So, it's only the first round and already we've got riveting football, including several nerve-racking endings to very close games. This is quite a change. It wasn’t so long ago that the World Cup’s first rounds lacked suspense -- so much so that some fans regretted FIFA’s decision to expand the number of participating teams to provide more slots for countries outside Europe and South America. That expansion has helped draw more fans around the globe to the World 104

Cup. It has also attracted players who, away from duty for the national team, play in similar club leagues and regional competitions -- particularly in Europe. There are also good reasons to argue that this year’s surprising World Cup has something to do with the earlier decisions by European national leagues to allow a larger number of foreign players to join individual teams. This provided valuable opportunities for talented players from Africa, Asia, Central America and the Middle East to develop their skills and acquire new ones in more competitive and better organized leagues. Players now get to know one another well before the major tournaments come along, and this reduces the intimidation that the nontraditional national teams inevitably feel when facing legacy powerhouses in the World Cup. The reverse flow of coaches and older players has also helped. Witness how many experienced western Europeans manage nontraditional teams. Meanwhile, even Major League Soccer, America’s nascent national club league, counts quite a few players among the national teams playing in Brazil. What is good for the sport as a whole, however, is not good for every team. Some of the more traditional national teams feel undermined by these changes, and there have been proposals in England to reimpose tighter limits on the number of foreign players on each league team. Many teams also think that club schedules make it hard to prepare for national games. Yet, there are ways for the older brand name teams to cope with the more challenging circumstances they face. It requires better discipline and organization, along with efforts to upgrade and modernized their playbooks. Germany, for example, has already done a lot of that (though even this perennial football power still isn't guaranteed safe passage out of the first round). I also think that this great, global contest we're watching offers some insights on broader challenges facing the world economy, in particular what countries and companies need to do better to increase growth, create jobs, reduce inequality and generate greater prosperity for the most people. To wit: • Improve the access of talent, no matter where it resides, to competitive venues that allow those people to develop. • Enable that talent to compete in a fair, competitive and rule-based environment. • Provide an organized context in which those now enjoying better access can occasionally go home to improve their local economies. • Adapt to changing circumstances and deploy better management practices so legacy economic titans don’t get paralyzed by paradigm shifts even if their historical advantages are eroding. There was a time when similar considerations underpinned regional and global efforts to promote freer and fairer trade in goods and services, together with safer movements of labor and capital. In recent years, however, that scenario has been undermined by the growth in nationalism and economic insularity fueled by prolonged periods of low growth and high unemployment. It might be time, as the World Cup reminds us, for a return to some first and simple principles. http://www.bloombergview.com/articles/2014-06-26/lessons-from-the-world-cup 105

+EUROPE Britain and Europe Are Heading for a Divorce

It's not him, it's them. Jun 25, 2014 9:03 AM EDT By Clive Crook British Prime Minister David Cameron is steeling himself for a defeat at this week's summit of European Union leaders in Ypres. Until recently, he expected to get his way over blocking the appointment of Jean-Claude Juncker as the next head of the European Commission. He dug himself in on that assumption. He now seems likely to be outvoted. Beyond the political embarrassment, here's why it matters: If the Tories win the next election, Cameron has promised Britain a vote on whether to stay in the EU. The quarrel over Juncker will be long past by then, but it will stand as a memorable instance of British frustration with the European project. Conceivably, it could make the difference in the referendum. Which only underlines how unwise Cameron was to make the appointment such a big deal. In case you've forgotten (and it's a forgivable error), he wants the U.K. to stay in the EU, though on new terms. Now his failed maneuverings over Juncker will just confirm that Europe isn't much interested in what Britain wants, proving Cameron's impotence and how little British preferences count. The Juncker affair is only partly Cameron's fault. Although he picks the wrong fights and his manner is grating, there's a deeper problem that the other EU governments seem incapable of recognizing. Juncker illustrates it perfectly. Cameron was tactically inept, but he's right on the merits of the appointment: Juncker's accession would move the EU two strides further in the wrong direction. First, Juncker is a federalist, a believer in the "ever closer union" inscribed in EU treaties. As head of the European Commission -- the union's powerful executive branch -- he'll be in a good spot to advance that purpose. He'll be deaf to the idea that Europe

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needs more "subsidiarity" (the principle that powers that don't need to be centralized shouldn't be) and hence to Britain's main preoccupation. Second, his appointment would be a coup for the European Parliament. Under current rules, national governments decide who leads the commission, and the understanding has been that this choice is made by consensus (that is, unanimously). The parliament, which wants Juncker, has no more than an advisory role. Yet it's being allowed to insist on Juncker, despite the misgivings of other leaders, and even though that overrides Britain's tacit veto. It's a perfect example of the very syndrome that infuriates Brits: the unlegislated drift of power from national governments to EU institutions. And it comes -- in the name of EU democracy, mind you -- after EU-wide elections in which parties opposed to that drift made great gains. As a result, Cameron's difficulties over Europe are rapidly compounding. His position requires him to argue that Europe is reformable; Europe is telling the world it isn't. How many of these rebuffs can Cameron absorb before he has to acknowledge that the U.K.'s choice is not between a new, less centralized union and divorce, but between divorce and the union as it is (only more so)? In effect, he's already cast aside the argument that Britain has a compelling interest in remaining an EU member on almost any terms. If he believed that, he wouldn't have promised a referendum in the first place. Will the U.K. move next to a more serious discussion of a British exit from the EU? Opinions are expressed on both sides, of course, but there's no real discussion. The loudest voices insist that Britain must quit to save its democracy -- or that leaving would cause such colossal economic harm that the idea is simply nuts. As yet, there's been no grappling with the trade-offs, no weighing of pros and cons. This ought to change. Perhaps it now will. The British, it seems fair to say, will never feel comfortable in the Europe envisaged by Juncker and his backers. And the kind of Europe in which they would feel at home is not what other governments appear to want, regardless of what their voters might prefer. Perhaps this should have been clear long ago; at any rate, it gets clearer all the time. A friendly dissolution begins to look more attractive -- and in the interests of all the partners. That conversation certainly isn't what Cameron wanted. Thanks to his own miscalculations and the obduracy of his EU counterparts, it's where Europe may be heading. http://www.bloombergview.com/articles/2014-06-25/britain-and-europe-are-heading- for-a-divorce

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Bruegel Europe needs new investment, not new rules - the EU must avoid another useless fight over its fiscal rules and instead use political capital to foster growth by Guntram B. Wolff 25th June 2014 169439 This opinion has been published by Kathimerini and other outlets. As the European Council meets in Brussels this week, the big debate on what a new policy deal for Europe could look like has re-emerged. Opponents group themselves around the famous “stability” vs “growth” camps, with the former arguing for the merits of fiscal discipline while the latter argues fiscal flexibility to finance reforms is more prudent. The “growth” camp points to the harsh reality that once the fiscal compact kicks in, it requires substantial savings by the government, while the “stability” camp emphasizes that this is exactly what is needed to render high debt levels and unfavourable debt dynamics more sustainable. In my view, the EU must avoid another useless fight over its fiscal rules and instead use political capital to foster growth. A deal could be designed along 3 central elements. The first element starts with the recognition that debt levels in several countries are already very high. The fiscal space to engage in a new stimulus as a growth instrument in those countries is simply not there and one must avoid risking a new financial crisis. In particular, in countries where the size of the state is already very large and the efficiency of the government sector is questionable, a new fiscal stimulus should be avoided. The most convincing national growth proposition in such circumstances is a serious reform of the state and an adjustment of fiscal expenditure away from rents to much more needed growth enhancing public goods. The current fiscal rules already allow a slow-down in fiscal consolidation in exchange for serious structural reforms. The second element of a deal would be recognizing that it is very difficult to maintain debt sustainable and primary surpluses high when euro area inflation rates are very low and real economic growth is as anaemic as it is currently. Arguably, the euro area needs a different macroeconomic policy stance. Yet, countries with high debt levels cannot provide a stimulus. The logical consequence is that countries that do have fiscal space, such as Germany, the Netherlands, Denmark, Sweden, Poland and Finland should start a public investment spending stimulus financed with deficits. Investment areas include the improvement of infrastructures such as roads and railways as well as increased spending in education and R&D. This would be good for several of the countries and especially for Germany, which in any case is investing far too little, but it would also have positive spill-over effects on 108

the euro area. This boost needs to be combined with an aggressive monetary policy stance. The third element is recognizing that Europe underinvests in European public goods. An investment boost in trans-European infrastructure would not only be beneficial for Europe’s single market, it would also constitute an important stimulus to economic growth. Which projects would be worthwhile undertaking and how could they be financed? The European energy network comes first to mind. In fact, with Ukraine’s gas supply crisis, the question of an adequate EU response to a potential gas shortage has become urgent. Building a better European energy network that could address energy shortfalls due to such external shocks is critical. Yet, much of the energy network as it stands currently is in private hands. A public intervention should prevent to crowd-out private investments or render private investments non-profitable and it therefore must focus on those parts of the network, which the private sector does not deliver. A further important area to invest public resources in is energy savings. Subsidizing and supporting investment in this area would not only make sense to meet Europe’s climate goals, it also can represent meaningful amounts of resources to have a macroeconomic impact on demand. Similarly, in the telecoms area, building a better European network makes sense, yet the public hand should not crowd out private spending. Therefore, support for broadband build-up and others networks must be focussed on areas, where the private sector would not typically invest, such as rural areas. In addition, more resources for a European mobility scheme for young workers would be useful. Funding for this investment boost should come from European funding mechanisms. The European Investment Bank as well as project bonds could be used much more aggressively to allow for additional European investments of at least €70 billion in 2015. Instead of wasting political capital on yet another reform of the Stability and Growth Pact, it is time for Europe to design a new deal on investment. Europe sorely needs this growth to meet its fiscal targets. | Read more at Bruegel http://www.bruegel.org/nc/blog/detail/article/1370-europe-needs- new-investment-not-new-rules/

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Daily Morning Newsbriefing June 25, 2014 Renzi says fiscal rules must change – or Europe dies We were struck by the headline in Huffington Post last night – The First Italian Failure since Renzi. Perhaps it was a desperate attempt by a hack to politicise a game. But it surely is a reminder of how close success and failure can be – this on the day when Matteo Renzi laid a claim to European leadership in a quite unparalleled way. At Eurointelligence we don’t usually focus on speeches, but Renzi’s address to the Italian parliament was quite extraordinary. On one level, it stood in the tradition of the big pro-European political speeches of Delors in Bruges 1989, Joschka Fischer in Berlin in 2000, but it is distinctly more aggressive. Renzi is essentially telling the Europeans what he has been telling the Italians – you do it my way, or you are doomed. While the EU is no stranger to aggressive rhetoric – like the early Nicolas Sarkozy for example – this is quite different. The following is our – in parts abridged - translation. Forgive me for being so swift, almost violent in my expression, but anyone who thinks that the democratic deficit is recovered by simply appointing Juncker or someone else to the presidency of the Commission, is living on Mars. The discussion on Thursday evening … must start from the realisation that the vacuum in Europe’s political institutions is filled with policies that are not a 'copy and paste' technocratic response but that solve the problems Europe has now, or risk losing a historic opportunity.” Referring to his own domestic 1000 day programme of transformation through political and economic reforms, he said the EU needs to apply the rules very differently. “We cannot continue to live in the Kafkaesque logic in which Europe applies an infringement procedure because you have not paid your debts to businesses, … and at the same time [forces you to do exactly that] with the Stability Pact.” He then compared this absurdity to a horror movie. He sees it as his historic duty to bring change – both to Italy and to Europe. “The work of Italy is not just to change Italy. Ladies and gentlemen, you represent the country that has given more to the European continent in terms of innovation, credibility and trust than any other. You sit in the seats from which generations of giants have enabled Europe to be what it is.” He is right on the substance. The way Italy complied with the stability pact during the Berlusconi/Monti period was by not paying its debt – which is what happens if you reduce the operational targets of fiscal policies to chase a particular number. As we remarked time and again, pro-cyclical austerity has deepened the eurozone crisis – which has nothing to do with the rules themselves but how they were applied. So we 110

agree with Renzi that the priority has to be on improving the quality of economic policy, not on rule change. We are just much less optimistic than he is about what can be done. As we are just witnessing the sad story of David Cameron’s over-reach, the EU does not respond to threats – though Renzi’s case is both substantively and politically more intelligent – and unlike Cameron has found political allies. We are just cautious given our knowledge about the limits of Germany’s readiness to move on this issue – see also Jens Weidmann’s intervention below. Francois Hollande, the less radical Renzi Francois Hollande is set to present his priorities for changing Europe at the Council meeting this week. Le Monde got hold of his speech, which seem to echo the proposals of Matteo Renzi and Sigmar Gabriel, though instead of a "radical change" advocated by Renzi, Hollande promotes change through slow metamorphosis. His speech will cover five main objectives: reorientation of economic policies towards more growth; fight against youth unemployment; a European energy policy; managing the immigration influx and a "simplification shock" for the EU institutions. Weidmann rejects loosening of the stability pact It is, of course, none of his business. We have made central banks independent so that they can get on with the business of monetary policy, and not to tell us how to run fiscal policy. Wolfgang Schauble, meanwhile, spends a lot of time talking about monetary policy. The significance of the intervention by Jens Weidmann in Suddeutsche Zeitung lies in how it shapes the debate on „flexibility“ in Germany. He writes that the calm in financial markets bears dangers in that it might make governments complacent. He recalled that the last time this happened, the community of member states had to construct a rescue umbrella, and that monetary policy came under pressure. In those crisis days everybody gave assurances that they favoured central controls. That implies that the fiscal rules should be strengthened and should become more binding. He then went on to criticise the current debate about a more flexible interpretation of the rules. By excluding investments from the deficit calculations, the debt-to-GDP ratio will be increasing, and that itself would bring new dangers. Who watchers the watchers, Part II After publishing allegations of skirting regulations for public tenders by fractioning contracts, El País continues its exposé of Spain’s court of Audit. This time it’s related to nepotism in hiring. The fact, illustrated by this infographic, is that some 100 of the court’s 700 employees are related to current or past high officials of the court. The Court explains that hiring takes place after a public competition (called ‘oposición’ in Spain) but court insiders allege that the contest is rigged. Internal critics have requested that the exam tribunals, made of 5 people, have at least 3 outside members when in practice the majority is formed by inside members. The demographic impact of Spain’s recession Spain’s national statistics institute INE release its basic demographic update for 2013. We found this striking chart where a clear correlation can be seen between births and the business cycle. 1997 was when the Spanish real estate bubble got started in earnest with the reform of land use legislation by the government of José María Aznar.

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The INE attributes the drop in births to lower fertility, but also to a reduction in the number of women of child-bearing age due to reduced migration and increased emigration (affecting primarily adults in prime working age) and also to the lagged effect of a reduction of birth rates in the late 1980s and early 1990s. Despite the recession’s negative impact on birth rates, the infant mortality rate continues to improve have dropped steadily from 3.9 to 2.8 per 1,000 live births in the last 10 years. In addition, life expectancy at birth continues to improve and now exceeds 80 year for both men and women. Insee sees French economic growth at 0.7% The latest forecast from Insee sees the French economy growing by 0.7% this year, significantly below the 1% forecast of the government, while unemployment is set to creep up to 10.2% this year compared with 10.1%. Several factors explain the persistent stagnation of the French economy, writes Le Monde. The purchasing power of households revived at last, but too little growth (+ 0.7%) to yield to a significant acceleration in consumption (+0.3%). A big factor is also construction. Investment into new housing contracted by 6.7%, two times more than in 2013 and its largest decline since 2009. Also investment spending is expected to rise only very slightly: + 0.7% over the year. On the supply side, the French economy benefits from the recovery in global trade but not as much as it could. The level of activity will depend on how the companies react to the government measures, but that these will kick in in 2015 anyway. Greek primary surplus beats target Greece's primary budget balance and its revenues have beaten their targets according to the deficit figures for the year’s first five months released by the Finance Ministry. The primary budget surplus was €707m in the year to end-May, compared with a target for just €208m. The total balance of the budget, including interest payments, showed a deficit of €1.99bn against a target for €2.55bn, according to Kathimerini. Macropolis reports the outperformance reflects lower expenditure (by €642m) and higher revenues (by €142m) more than offsetting lower Public Investment Budget balance (€129m) than the target. According to the MoF, corporate income tax outperformed the 5-month target by €274m, while personal income tax fell short of target by €95m. Households and corporate unpaid taxes, meanwhile, rose by €4.33bn in the 4-month period. Despite the 112

strong revenue rebound in May, the 5-month net revenues remained slightly lower year on year (-0.8 %) to €17.3bn, due to increased tax refunds. On the expenditure side, the drop in primary expenditure slightly accelerated to -3.3% in May (from -2.7% in April) leading the 5-month figure of €16.64bnn. The latter continues to beat (the revised) target by 2.7% or €459m. Dixon says Samaras populist strategy could backfire Hugo Dixon of Reuters Breakingviews writes that Antonis Samaras strategy to choose populist ministers, who question reforms already agreed, in response to the EU election results could backfire later. Even if Samaras gets them back in line it is clear that this government is less effective to deliver reforms than the last. This is unfortunate because whether or not Greece will get a debt relief talk or not will depend on whether the country can deliver reforms. There is also lingering uncertainty about how much money the Greek state will have to pump into the banks. The more time is lost the closer it gets to the president election, where a candidate needs 60% of parliamentary backing, a critical test for Samaras, and if no candidate wins the backing there will be early elections. If by that time Samaras cannot provide a narrative that reforms pay off with an agreed debt relief deal, people will vote for populism and Syriza is likely to be the winner then. LSE blog: Belgium to face another political deadlock Belgium held federal elections in May, with negotiations currently on-going over the makeup of the next government. As Peter Van Aelst writes on the LSE blog, the country could experience political deadlock of the kind which occurred after the 2010 elections, where it took 541 days of negotiations before a government could be formed. He notes that while there appears to be more urgency than there was in 2010, the situation is complicated enough to suggest that it will be another long process. Belgium is the most politically fragmented country, where it is easier to form a regional government than a federal one. In a climate of mistrust between the parties and Wallonian parties this time less eager to participate in a federal government than the Flemish, the government building process is set to be long and wary. Does it matter if Belgium has no real government for such a long time? Van Aelst says, no, not really. The regional level is still working, and without the government/opposition divide, parlamentarians have more freedom to pass through more legislation as they did in the past. It also should not impact on the country's credit worthiness, as the rise in bond yields after the 2010 elections had more to do with the financial than with the political crisis, writes van Aelst. Why does nobody care about ESM recaps? Silvia Merler has a comment on the Bruegel website that the recent ex-post agreement on ESM recapitalisations in the interim period is neither here nor there. She noted that the agreement itself attracted remarkably little attention. Why is this so, given how important such an agreement could be in breaking the links between sovereigns and their banks? There are two reasons. The sense of urgency disappeared with the end of the crisis. But there is also a substantive reason. This agreement is not a game changer. In particular, the ESM now says quite explicitly that the objectives have changed over the years. The article goes into some detail of when direct capitalisation can be applied – it really is a last resort (and may never be used anyway).

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“Ultimately, the problem of ESM direct recap is that its initially clear purpose got lost in translation among the political attempts to meet numerous and conflicting objectives. “ The significance of Elliott vs Argentina for the eurozone Like Felix Salmon we also believe that the US Supreme Court ruling is hugely significant for sovereign debt markets – in a way that is not yet sufficiently understood by governments and by market participants. This is a very long article. Salmon’s own short introductory summary reads: “ The consequences are certain to be dreadful for Argentina. More broadly, the ruling will make it more difficult for countries to free themselves from the burden of over- indebtedness. It will be very bad for international capital markets. Oh -- and it will also diminish national sovereignty.” He does a good job explaining the history of the case, which we cannot go into here. The legal implication of this ruling is that sovereign default is now made much more difficult. Default will from now go hand in hand with the collapse of states. Here is what happens when a country seeks to default: “If a country does default on debts, then it needs some way to cure that default, reenter the international financial system, and give itself and its companies the ability to fund themselves with debt. Because countries can’t declare bankruptcy, exchange offers are the next best thing. But for those to work, a debtor country needs to be able to pay the exchange bondholders without paying the holdouts. Otherwise, no one would ever participate in an exchange, and no country could ever restructure its debts.” The crux is that the US legal system has ultimate control over some elements of that payment chain. The article goes into some length of what can happen now, but the options are Argentina are all not good. About Finland and competitiveness Risto Penttila wonders in the FT how come that Finland is at top of the World Economic Forum’s competitiveness index when the country is in a massive recession that is to a large part due to a loss of competitiveness of Nokia, the country’s dominant corporation. He gives an impressive list of what is wrong in Finland. “For a start, Finland’s economy has not grown in five years. The unemployment rate is 9 per cent. The flagship company, Nokia, was forced to sell its handset business to Microsoft last year. Its shipyards are in trouble; its forestry companies are cutting costs and closing plants. Public expenditure is expected to reach 58 per cent of gross domestic product this year – a larger share of output even than France. Its middle class pays one of the highest income tax rates in Europe. Its public debt is growing. And matters will only worsen: the Finnish population is ageing faster than that of any other European country.” The answer to his question is very simple. Competitiveness indices are utter garbage. Competitiveness applied to national states is a category error, invented by business school professors who made money by translating a concept that is useful at corporate level to an economy. As the case of Finland shows, it does not even apply to small open economies. Rogoff on how the eurozone should resolve the sovereign debt crisis 114

Ken Rogoff, writing in FAZ, has a good comment in FAZ, warning Germany not to force the debt repayment of its eurozone debtors. He writes that even if Northern Europe were to succeed to force the periphery to do repay the debt, it would be a mistake. It would be much better to accept a drastic reduction in sovereign debt through the bail-in of private creditors and with the help of maturity extensions. There will be losses to the northern European states, but these losses will be smaller than the losses of a permanently depressed eurozone. That would also much more powerful than a fiscal stimulus programme for Germany. We continue to disagree with him on the effectiveness of fiscal policy, which we think is particularly useful in times of a balance sheet recession. But his main point is very important – that a debt conference is the way to go. There can be no sustainable economic recovery given some of the large sovereign and private sector debt exposures. Eurozone Financial Data 10y spreads

Previous This Yesterday day Morning France 0.352 0.340 0.345 Italy 1.474 1.463 1.475 Spain 1.372 1.343 1.374 Portugal 2.214 2.154 2.176 Greece 4.659 4.519 4.60 Ireland 1.103 1.077 1.113 Belgium 0.470 0.453 0.466 Bund Yield 1.324 1.322 1.31

exchange rates This Previous morning Dollar 1.359 1.3605 Yen 138.610 138.61 Pound 0.799 0.8009 Swiss Franc 1.217 1.2163

ZC Inflation Swaps previous last close

1 yr 0.74 0.74 2 yr 0.84 0.85 5 yr 1.23 1.22 10 yr 1.66 1.65

Eonia 24-Jun-14 0.04 115

23-Jun-14 0.03 20-Jun-14 0.03 19-Jun-14 0.01

OIS yield curve 1W 0.070 15M 0.040 2W 0.058 18M 0.045 3W 0.053 21M 0.062 1M 0.059 2Y 0.087 2M 0.067 3Y 0.152 3M 0.075 4Y 0.259 4M 0.076 5Y 0.395 5M 0.075 6Y 0.564 6M 0.029 7Y 0.739 7M 0.073 8Y 0.903 8M 0.070 9Y 1.065 9M 0.068 10Y 1.206 10M 0.067 15Y 1.703 11M 0.067 20Y 1.932 1Y 0.067 30Y 2.065

Euribor-OIS Spread previous last close

1 Week -2.286 0 1 Month 3.086 2.386 3 Months 10.586 10.286 1 Year 37.671 37.471

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-06- 25.html?cHash=6c0afd6ef791f099dc5e9df8d7b08993

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MODERN MONEY THEORY: THE BASICS Author: L. Randall Wray · June 24th, 2014 · *I’ll return to my series on the role of taxes in MMT later this week. Meanwhile, here’s a short post on MMT. Modern Money Theory (MMT) seems to confuse two groups of otherwise sympathetic economists. First there are those like Paul Krugman who are generally of the Keynesian persuasion and who like MMT’s “deficit owl” approach. I think Krugman would really like to stop worrying about the deficit so that he could advocate an “as much as it takes” approach to government spending. The problem is that he just cannot quite get a handle on the monetary operations that are required. Won’t government run out? What, is government going to create money “out of thin air”? Where will all the money come from? He really doesn’t understand that “money” is key stroke records of debits and credits. He still thinks banks take in deposits and then lend them out. He starts to tear his hair out whenever someone tries to correct him on this. He’s wedded to the deposit multiplier idea he got from his Econ 101 textbook. The other group that is otherwise sympathetic is the Post Keynesians. They understand banking. They know that “loans create deposits”. They know the “deposit multiplier” is actually a “divisor”, as “deposits create reserves”. (Not in any metaphysical sense but rather in the sense that an interest rate-targeting central bank always accommodates the demand for reserves.) However, they cannot understand how a sovereign government spends. Doesn’t it have to borrow the currency from private banks? Like Krugman, they argue that (given modern arrangements), government cannot spend by “keystrokes”. So here’s an attempt to put the fears of Krugman and Post Keynesians to rest. There is a symmetry between bank lending and government spending. I also hope to help clarify things for a third group—the “debt-free money” folks who want Uncle Sam to spend “debt-free money”. Short answer: depending on how you look at it, he either already does, or cannot ever do so. Here we go with the basics of MMT. For the past four thousand years (“at least”, as John Maynard Keynes put it—see note at bottom), our monetary system has been a “state money system”. To simplify, that is one in which the state chooses the money of account, imposes obligations denominated in that money unit, and issues a currency accepted in payment of those obligations. While a variety of types of obligations have been imposed (tribute, tithes, fines, and fees), today taxes are the most important monetary obligations payable to the state in its own currency. There is an approach that begins its analysis of money from this perspective, now called Modern Money Theory (MMT). It is based on the work of Keynes, but also on others 117

such as A. Mitchell Innes, Georg F. Knapp, Abba Lerner, Hyman Minsky, Wynne Godley, and many others—stretching back to Adam Smith and before. It “stands on the shoulders of giants”, as Minsky put it. Its research has stretched across the sub-disciplines of economics, including history of thought, economic history, monetary theory, unemployment and poverty, finance and financial institutions, sectoral balances, cycles and crises, and monetary and fiscal policy. It has largely updated and synthesized various strands of theory, most of it heterodox—outside the mainstream. Perhaps the most important original contribution of MMT has been the detailed study of the coordination of operations between the treasury and the central bank. The central bank is the treasury’s bank, making and receiving payments on behalf of the treasury. The procedures involved can obscure how the government “really spends”. While it was obvious two hundred years ago that the national treasury spent by issuing currency, and taxed by receiving its own currency in payment, that is no longer so obvious because the central bank stands between the treasury and recipients of government spending as well as between treasury and taxpayers making payments to government. However, as MMT has shown, nothing of substance has changed—even though taxpayers today make payments from their private bank accounts, and banks make the tax payments to treasury for their depositors using reserves held at the central bank. And when treasury spends, its central bank credits reserve accounts of private banks, which credit deposit accounts of recipients of the government spending. In spite of the greater complexity involved, we lose nothing of significance by saying that government spends currency into existence and taxpayers use that currency to pay their obligations to the state. MMT reaches conclusions that are shocking to many who’ve been indoctrinated in the conventional wisdom. Most importantly, it challenges the orthodox views about government finance, monetary policy, the so-called Phillips Curve (inflation- unemployment) trade-off, the wisdom of fixed exchange rates, and the folly of striving for current account surpluses. For most people, the greatest challenge to near-and-dear convictions is MMT’s claim that a sovereign government’s finances are nothing like those of households and firms. While we hear all the time the statement that “if I ran my household budget the way that the Federal Government runs its budget, I’d go broke”, followed by the claim “therefore, we need to get the government deficit under control”, MMT argues this is a false analogy. A sovereign, currency-issuing government is NOTHING like a currency- using household or firm. The sovereign government cannot become insolvent in its own currency; it can always make all payments as they come due in its own currency. Indeed, if government spends currency into existence, it clearly does not need tax revenue before it can spend. Further, if taxpayers pay their taxes using currency, then government must first spend before taxes can be paid. Again, all of this was obvious two hundred years ago when kings literally stamped coins in order to spend, and then received their own coins in tax payment. Another shocking truth is that a sovereign government does not need to “borrow” its own currency in order to spend. Indeed, it cannot borrow currency that it has not already spent! This is why MMT sees the sale of government bonds as something quite different from borrowing. 118

When government sells bonds, banks buy them by offering reserves they hold at the central bank. The central bank debits the buying bank’s reserve deposits and credits the bank’s account with treasury securities. Rather than seeing this as borrowing by treasury, it is more akin to shifting deposits out of a checking account and into a saving account in order to earn more interest. And, indeed, treasury securities really are nothing more than a saving account at the Fed that pay more interest than do reserve deposits (bank “checking accounts”) at the Fed. MMT recognizes that bond sales by sovereign government are really part of monetary policy operations. While this gets a bit technical, the operational purpose of such bond sales is to help the central bank hit its overnight interest rate target (called the fed funds rate in the US). Sales of treasury bonds reduce bank reserves and are used to remove excess reserves that would place downward pressure on overnight rates. Purchases of bonds (called an open market purchase) by the Fed add reserves to the banking system, prevent overnight rates from rising. Hence, the Fed and Treasury cooperate using bond sales/bond purchases to enable the Fed to keep the fed funds rate on target. You don’t need to understand all of that to get the main point: sovereign governments don’t need to borrow their own currency in order to spend! They offer interest-paying treasury securities as an instrument on which banks, firms, households, and foreigners can earn interest. This is a policy choice, not a necessity. Government never needs to sell bonds before spending, and indeed cannot sell bonds unless it has first provided the currency and reserves that banks need to buy the bonds. So, much like the relation between taxes and spending—with tax collection coming after spending–we should think of bond sales as occurring after government has already spent the currency and reserves. Most Americans are familiar with the phrase “raise a tally”, which referred to the use of notched “tally sticks” that served as the currency of European monarchs. The sticks were split (into a stock and stub) and matched by the exchequer on tax day. The crown’s obligation to accept his tally debt was “wiped clean” just as the taxpayer’s obligation to deliver the tally debt was fulfilled. Clearly, the taxpayer could not deliver tally sticks until they had been spent. It surprises most people to hear that banks operate in a similar manner. They lend their own IOUs into existence and accept them in payment. A hundred years ago, a bank would issue its own banknotes when it made a loan. The debtor would repay loans by delivering bank notes. Banks had to create the notes before debtors could pay down debts using banknotes. In the old days in the US, notes issued by various banks were not necessarily accepted at par—if you tried to pay down your loan from St. Louis Bank using notes issued by Chicago Bank, they might be worth only 75 cents on the dollar. The Federal Reserve System was created in part to ensure par clearing. At the same time, we essentially taxed private bank notes out of existence. Banks switched to the use of deposits and cleared accounts among each other using the Fed’s IOUs, called reserves. The important point is that banks now create deposits when they make loans; debtors repay those loans using bank deposits. And what this means is that banks need to create the deposits first before borrowers can repay their loans.

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Hence, there is a symmetry to the way the sovereign spends currency (or central bank reserves) into existence first, and then taxpayers use the currency (or central bank reserves) to pay taxes. Sovereigns spend first, then tax. In that sense, they do not “need” tax revenue in order to spend. This does not mean that sovereigns can stop taxing, however. MMT says that one of the purposes of the tax system is to “drive” the currency. One of the reasons people will accept the sovereign’s currency is that taxes need to be paid in that currency. From inception of the currency, no one would take it unless the currency was needed to make a payment. Taxes and other obligations create a demand for the currency that can be used to make the obligatory payments. Note that we can say something similar about banknotes and bank deposits. Part of the reason we will accept them in payment is because “we” (at least, many of us) have obligations that need to be paid using banknotes or bank deposits. We’ve got a mortgage debt, or a credit card debt or a car loan debt—all of which normally are paid by writing a check on our bank deposit account. We can fill-up that account by accepting checks drawn on other bank deposit accounts, and with the Fed ensuring par clearing, our bank will accept those checks. While there is a symmetry between government currency issue and private bank issue of notes or deposit, there are also asymmetries. Government imposes a tax obligation on (at least some) citizens. Private banks rely on customers voluntarily entering into an obligation (that is, they decide to become borrowers). We can all “choose” to refuse to become borrowers, but as they say, the only thing certain in life is “death and taxes”—these are much harder to avoid. Sovereign power is usually reserved to the state. This makes its own obligations— currency and reserves—almost universally acceptable within its jurisdiction. Indeed, banks and others normally make their own obligations convertible into the state’s obligations. This is why we call bank checking accounts “demand deposits”: banks promise to exchange their own obligations to the state’s obligations on “demand”. For this reason, MMT talks about a “money pyramid”, with the state’s own currency at the top. Bank “money” (notes and deposits) are below the state’s “money” (reserves and currency). We can think of other financial institution liabilities as below “bank money” in the pyramid, often payable in bank deposits. Lower still we find the liabilities of nonfinancial institutions. And at the bottom we might find the IOUs of households— again normally payable in the obligations of financial institutions. A lot of people have great difficulty in getting their heads around all this “money creation” business. It sounds like alchemy or even fraud. Banks simply create deposits when they make loans? Government simply creates currency or central bank reserves when it spends? What is this, creation of money out of thin air? Yes, indeed. Hyman Minsky used to say that “Anyone can create money”; but “the problem lies in getting it accepted”. You must understand that “money” is by nature an IOU. You can create a dollar-denominated “money” by writing “IOU five dollars” on a slip of paper. Your problem is to get someone to accept it. Sovereign government has an easy time finding acceptors—in part because millions of us owe payments to government.

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Bank of America has an easy time finding acceptors—in part because millions of us owe payments to Bank of America, in part because we know we can exchange deposits at the bank for cash, and in part because we know the Fed stands behind the bank to ensure par clearing with any other bank. However, very few people owe you, and we doubt your ability to convert your IOU to Uncle Sam’s IOU at par. You are low in that money pyramid. Both Uncle Sam and Bank of America are constrained in their “money creation”, however. Uncle Sam is subject to the budget authority that is provided by Congress and the President. Occasionally he also bumps up against the crazy (yes, crazy!) Congressionally-imposed “debt limit”. Congress and the President could and should remove that debt limit, but we surely do want a budgeting process and we want to ensure that Uncle Sam is constrained by the approved budget. Still, Uncle Sam ought to be spending more whenever we’ve got unemployment. Bank of America is subjected to capital constraints and limits on the types of loans it can make (and types of other assets it can hold). Yes, we freed the banks from most regulations and supervision over the past couple of decades—to our regret. Those with the “magic porridge pot” do need to be constrained. Banks can, and frequently do, make too many (bad) loans—which can bubble up markets and create solvency problems for them and even for their customers. Prudent lending is a virtue that ought to be required. The problem is not the “thin air” nature of the creation, but rather the quantities of “money” created and the purposes for which it was created. Government spending for the public purpose is beneficial, at least up to the point of full employment of the nation’s resources. Bank lending for public and private purposes that are beneficial publicly and privately is also generally desirable. However, lending comes with risk and requires good underwriting (assessment of credit worthiness); unfortunately our biggest banks largely abandoned the underwriting process in the 1990s, with disastrous results. One can only hope that policy-makers will restore the good banking practices that were developed over the past half-millennium, shutting down the largest dozen global banks that have no interest in good banking. Some have given up hope in our banking system. I’m sympathetic to their pessimistic views. Some want to go back to “greenbacks” or to the Chicago Plan’s “narrow banks”. Some even want to eliminate private money creation! Have the government issue “debt- free money”! I’m sympathetic, but I don’t support the most extreme proposals even if I support the goals. Such proposals are based on a fundamental misunderstanding of our monetary system. Our system is a state money system. Our currency is government’s liability, an IOU that is redeemable for tax obligations and other payments to the state. The phrase “debt-free money” is based on a misunderstanding. Remember, “anyone can create money”, the “problem is to get it accepted”. They are all IOUs. They are either spent or lent into existence. Their issuers must accept them in payment. They are accepted by those who will make payments, directly or indirectly, to the issuers. In the developed nations we have thoroughly monetized the economies. Much (maybe most) of our economic activity requires money, and we need specialized institutions that can issue widely accepted monetary IOUs to enable that activity to get underway.

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While our governments are large, they are not big enough to provide all the monetary IOUs we need for the scale of economic activity we desire. And we—at least we Americans—are skeptical of putting all monetized economic activity in the hands of a much bigger government. I cannot see any possibility of running a modern, monetized, capitalist economy without private financial institutions that create the monetary IOUs needed to initiate economic activity. The answer, it seems to me, to our current financial calamities does not reside in elimination of our for-profit financial institutions, even if I do see a positive role to be played by new public financial institutions (maybe some national development banks and some state development banks and a revived postal saving system?). We do, however, need fundamental reform—including downsizing (probably breaking up or closing) of the behemoths, greater oversight, more transparency, prosecution of financial fraud, and putting more of the “public” in our “public-private partnership” banking institutions. Note: See L. Randall Wray, Understanding Modern Money: the key to full employment and price stability, Edward Elgar 1998; and Wray, Modern Monetary Theory: A Primer on Macroeconomics for Sovereign Monetary Systems, Palgrave Macmillan, 2012. - See more at: http://www.economonitor.com/lrwray/2014/06/24/modern-money- theory-the- basics/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+econ omonitor%2FOUen+%28EconoMonitor%29#sthash.16sG6Kkh.dpuf

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Economía El economista de Harvard Kenneth Rogoff Alemania no puede resolver todos los problemas de Europa La economía alemana está en los otros europeos en las críticas. Pero si Alemania gasta más dinero no ayuda. El endeudamiento es el problema. Un puesto de invitado por Kenneth Rogoff.

© dpa en el acorde para la exportación: los empleados de BMW trabajan en la planta de Leipzig sobre los coches eléctricos i3 Alemania tenía que ser una fuerza impulsora fuerte para el crecimiento económico europeo y mundial, es una de las demandas más frecuentes de los comentaristas internacionales. Con un superávit en cuenta corriente de más del 7 por ciento del producto interno bruto, la proporción de las exportaciones es demasiado alta y la tasa de ahorro es muy baja - muy a pesar de sus vecinos, es el tenor general. Competitividad trabajadores alemanes era demasiado alto y la participación del gobierno es demasiado bajo. Aunque estas teorías no son enteramente ser despedido de las manos, pero muy exagerados, son todos. La economía alemana se ha discutido en varias ocasiones en los debates macroeconómicos de todo el mundo durante las últimas seis décadas. Durante la era de Bretton Woods de tipos de cambio fijos, como numerosos países, incluyendo el Reino Unido, vio regularmente forzada a devaluar su tipo de cambio frente al dólar, Alemania tuvo que revalúe su tipo de cambio en varias ocasiones. Final de los años setenta se practica la autoridades monetarias estadounidenses de alta presión en Alemania y

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Japón, ya que exigían un fuerte incremento en el gasto del gobierno para impulsar lo que la demanda global. Campaña de desprestigio sin escrúpulos Incluso durante la crisis del Sistema Monetario Europeo en 1992, cuando el primer intento de una moneda única no, parecía que algunos comentaristas, la política alemana de la estabilidad de las monedas inestables de otros países de la culpa. Y el año pasado el Tesoro de EE.UU. reiteró su crítica de que Alemania no estaba dispuesto a participar de Europa y del mundo, con un paquete de estímulo más grande debajo de los brazos. Por el contrario, los estudios realizados por el Fondo Monetario Internacional (FMI) de que un programa de estímulo alemán a gran escala no atraería a los beneficios deseados para todos los países de la periferia de Europa después de sí mismos. Un programa de estímulo económico de Alemania, los Estados Unidos, Asia y Europa central se beneficiaría principalmente porque no es el centro de la cadena de suministro alemana. Las exportaciones de los países periféricos a Alemania simplemente no son lo suficientemente altos para sustancialmente a la materia.

© bienestar, Rainer Kenneth Rogoff, profesor norteamericano de la Universidad de Harvard y ex economista jefe del Fondo Monetario Internacional Pero a pesar de todos los argumentos sólidos del FMI mantener los ultra-keynesianos firme a sus convicciones: un aumento masivo en el gasto gubernamental alemana maravillas para los países periféricos, mientras que al mismo tiempo causa un costo mínimo para Alemania. Los alemanes son una tontería si estaban preocupados por la deuda pública, los pasivos por pensiones sin reservas y el futuro esperado, los costos ocultos de los rescates bancarios y la rehabilitación nacional. En ausencia de argumentos tangibles, los ultra-keynesianos lanzó una campaña de desprestigio en contra de cualquier defensores inescrupulosos una eliminación de la espiral de la deuda a largo plazo como resultado de la crisis financiera. La deuda no es simplemente un problema. Las exageraciones masivas de los ultra-keynesianos (sólo una vez consideran que sus profecías no calificados de la caída de Gran Bretaña, el país está experimentando un boom) no quiere decir acerca de que la política alemana era siempre la correcta. Alemania podría, por supuesto, iniciar reformas estructurales con el fin de fortalecer su economía y promover la competencia. Sin embargo, si un país que ya tiene un mercado laboral sólido, los argumentos a favor de un aumento de las inversiones en infraestructura no son tan convincentes como en el caso de los Estados Unidos. Dados los excepcionalmente bajos tipos de interés de los bonos del gobierno alemán, la relación coste-eficacia de las inversiones en infraestructura, pero en realidad parece muy atractivo, especialmente identificadas por las deficiencias de la Comisión Europea en los ámbitos de las redes eléctricas y de banda ancha no deben ser despedidos de las manos. 124

Corte de pelo dramático como una solución Alemania también se puede hacer más para mejorar su sistema educativo, por ejemplo, mediante el aumento de la competencia entre las universidades y la inversión más alta y de base amplia en la formación y la educación. Además, la inversión privada en servicios y venta al por menor podría ser fomentada por una mayor desregulación. Irónicamente, estas medidas positivas no dejaban que las quejas sobre el silencio de austeridad alemana - después de todo, ellos ampliar la ventaja competitiva de Alemania en el largo plazo sólo es más. Pero podrían reducir el superávit en cuenta corriente como un paquete total de medidas de mayo. Desafortunadamente, sin embargo, incluso un aumento sustancial de la inversión alemana difícilmente beneficiarán a los países periféricos siguen muy endeudados. Como se ha demostrado en decenas de estudios, el endeudamiento privado, público y externo sigue siendo un obstáculo para el crecimiento en la periferia y la inversión en la zona euro. Los gobiernos de Europa han hecho realidad beneficiado enormemente de las tasas de interés significativamente más bajos que prevalecieron Mario Draghi del Banco Central Europeo, con sus medidas drásticas; pero las pequeñas y medianas empresas todavía tienen enormes dificultades para acceder a préstamos. Más sobre// En Inglés: La locomotora alemana se está moviendo lo suficientemente rápido / Ataque sobre el Pacto de Estabilidad y Crecimiento: La deuda está lejos de estar bajo control de / Nadie tiene la intención de modificar el Pacto de Estabilidad! / Advertencia del BCE: "No repitamos el error de 2003" La ayuda de nadie por el vicerrector Durante mucho tiempo he sido de la opinión: Incluso si fuera posible el norte de Europa, una política de ahorro enérgico para cometer los países periféricos a la devolución total de su deuda, que sería un error. Un corte de pelo radical, como la obligación impuesta a los prestamistas privados a la extensión de por vida como un requisito obligatorio para las subvenciones oficiales, sería el enfoque mucho mejor. Que la pérdida de los países del norte de Europa por reembolsos perdidos también ser alto - largo plazo convalecía, zona euro más productivo sería compensar estas pérdidas. Un alivio de la deuda de los países periféricos sin duda, sería un enfoque mucho más útil que un paquete de estímulo costosa Alemania. ¿Quién la solución de todos los problemas que se ven en las medidas de política fiscal, puede parecer a Francia - un país que tiene muchos puntos fuertes, pero eso no puede entrar en juego por un aparato de gobierno hinchada enorme. Francia iniciaría las reformas estructurales, como en Alemania o Suecia, hace una década, hace dos décadas, la zona euro podría beneficiarse enormemente. Además de los efectos secundarios directos ganaría en Alemania una nueva confianza que usted tiene un verdadero asociados en la ejecución en la zona euro. Sí, Alemania debería haber tomado antes generosa se manifiestan contra los países periféricos - mediante la demostración de nuevas formas de reducir la deuda y el apoyo a las reformas estructurales. Sin embargo, la idea de que se podría resolver a Alemania en la forma de una locomotora gigante pasar todos los problemas es, por desgracia una falacia.

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Le Monde Les priorités de Hollande pour changer l'Europe Le Monde.fr | 24.06.2014 à 11h43• Mis à jour le24.06.2014 à 12h12 |Par Alain Salles Abonnez-vous à partir de 1 € Réagir Classer Partagerfacebooktwittergoogle +linkedinpinterest

Fran çois Hollande et Matteo Renzi, le 21 juin à Paris. | REUTERS/POOL Sonné par le résultat des élections européennes, François Hollande compte bien faire entendre sa voix au Conseil européen des 26 et 27 juin et défendre une politique qui mise sur la relance et l'investissement, plutôt que sur l'austérité défendue par la chancelière allemande, Angela Merkel. Il propose « un agenda pour la croissance et le changement en Europe » qu'il adresse, mardi 24 juin, au président du Conseil européen, Herman Van Rompuy, chargé d'établir les priorités de la prochaine Commission européenne. Le texte en préparation depuis plusieurs semaines a été finalisé après une réunion ministérielle sur les priorités de l'Europe à l'Elysée lundi 23 juin et la réunion des chefs de gouvernement sociaux- démocrates de l'UE à Paris, le 21 juin, qui a redonné des couleurs au centre-gauche européen. L'Elysée s'est fixé cinq grandes priorités pour renforcer l'Europe de demain : une politique économique orienté vers la croissance ; la lutte contre le chômage des jeunes ; une politique européenne de l'énergie ; la maîtrise des flux migratoires et enfin un « choc de simplification » pour les institutions. 127

« GRANDE BATAILLE » Le texte – que le Monde s'est procuré – est dans la droite ligne des idées développées lors de la réunion des chefs de gouvernement sociaux-démocrates. Il fait écho aux propositions du premier ministre italien, Matteo Renzi, tout comme à celle du SPD allemand. Mais là où M. Renzi prône un « changement radical », M. Hollande mise sur une métamorphose progressive vers une Europe plus souple et plus sociale. L'objectif est de faire passer ses idées sur l'investissement et la flexibilité budgétaire, en échange du soutien au candidat de la droite à la tête de la Commission, Jean-Claude Juncker. En espérant ne pas trop heurter Mme Merkel. A l'Elysée, on s'attend cependant à une « grande bataille », vendredi à Bruxelles entre les partisans de la rigueur et ceux de la relance. http://www.lemonde.fr/europe/article/2014/06/24/les-priorites-de-hollande-pour-changer-l- europe_4444224_3214.html 17 mars 2014 Juncker : « Le prochain président de la Commission sera soit Schulz, soit moi »

Jean-Claude Juncker lors du congrès électoral du PPE, le 7 mars à Dublin. Peter Muhly/AFP

Jean-Claude Juncker est le chef de file du Parti populaire européen (PPE) pour les élections de mai 2014. Il aura notamment pour adversaire le social-démocrate allemand Martin Schulz, candidat à la succession de José Manuel Barroso à la présidence de la Commission européenne. Dans un entretien au Monde, l’ancien président de l’Eurogroupe précise ses intentions, et répond à ses détracteurs qui critiquent le retour de l’ancien premier ministre du Luxembourg, un pays considéré par la gauche comme un « paradis fiscal ». Le flou demeure sur vos intentions réelles. Êtes-vous candidat à la tête de la Commission ? Jean-Claude Juncker : Il est évident que je veux devenir président de la Commission. Un train n’en cache pas un autre. Il est exclu à ce stade que je devienne président du Conseil européen. J’ai dit en plaisantant que je ne n’étais pas vexé que mon nom soit évoqué pour les deux postes. A partir du moment où les partis politiques européens ont décidé de faire campagne avec des chefs de file, la formation qui reçoit le plus grand nombre de sièges va devoir proposer le président de la Commission. On peut donc dire que son prochain président sera soit Martin Schulz, soit moi. Si les partis devaient décider d’inventer un troisième candidat, cela reviendrait à tromper les électeurs.

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Le PPE est-il unanime ? Angela Merkel n’a pas l’air favorable à ce principe… La chancelière allemande a dit qu’il n’y a pas d’automaticité. Mais je pars du principe que si le PPE gagne, il me proposera à la présidence de la Commission et cherchera un consensus avec le Parlement européen. Qu’est ce qui vous différencie de Martin Schulz ? Ce n’est pas un ennemi, mais un compétiteur. Nous sommes d’accord sur de nombreux points. Nous ressentons tous les deux l’ardente obligation pour notre génération de ne pas laisser le projet européen se perdre dans certaines dérives. L’Europe omniprésente, qui s’immiscerait dans la vie de tous les citoyens, est un développement qui ne correspond pas à l’exigence de s’occuper d’abord des grands problèmes. Cela dit, les partis démocrates-chrétiens et conservateurs sont plus à même de redresser l’économie, de renforcer la compétitivité européenne et de trouver la bonne combinaison entre solidité et solidarité. Craignez-vous l’opposition de David Cameron à votre désignation ? Je n’ai jamais parlé de ma candidature avec David Cameron, qui ne fait pas partie de mon groupe sanguin. Il est préférable de se mettre d’accord avec les Britanniques, mais au sein du Conseil européen, la décision peut être prise à la majorité qualifiée, en tenant compte du résultat des élections européennes. Le scrutin s’annonce très serré. Certaines estimations placent les socialistes en tête. Est-ce le contrecoup de la crise de la zone euro ? Je ne crois pas trop à ces sondages. Et je m’inscris en faux contre l’idée que le centre- droit et les partis démocrates-chrétiens constitueraient le camp de l’austérité et les socialistes, le camp de la générosité. Au sein de la zone euro, douze pays ont connu des gouvernements socialistes pendant la période où j’ai présidé l’Eurogroupe. Or je n’ai pas vu de ministres des finances socialistes démissionner par désaccord avec la politique menée. Au contraire, j’ai constaté que certains, aux Pays-Bas ou en Finlande, étaient parmi les plus exigeants à l’égard de la Grèce et des pays en difficulté. Angela Merkel a quand même beaucoup insisté sur l’austérité… C’est une perception erronée de croire qu’Angela Merkel a imposé son rythme et sa doctrine pour gérer la crise. Le camp de la rigueur a été très œcuménique. L’Allemagne n’aurait pas pu imposer sa volonté si les autres gouvernements n’avaient pas fait la même analyse. Y-a-t-il une différence entre gauche et droite en matière de politique économique ? Je ne crois pas. A une époque, il y avait treize premiers ministres de gauche au sein du Conseil européen. Nous étions deux représentants de droite : l’Espagnol José Maria Aznar et moi-même. La politique néolibérale a été mise en place à cette époque-là. Lionel Jospin était vraiment de gauche mais Gerhardt Schröder, en Allemagne, et Tony Blair, au Royaume-Uni, ne m’ont jamais dépassé sur la gauche ! Comment réagir à la montée des forces eurosceptiques ? Il faut être aveugle pour ne pas voir que l’Europe est frappée d’un désamour grandissant. Dans chacune de nos Etats, le fossé entre classe politique et société civile est très large. Il est encore plus large concernant les institutions européennes. Cela est dû au fait que l’Europe s’occupe trop de choses non essentielles. Elle donne souvent l’impression d’être davantage un ring de boxe qu’une enceinte à la recherche de l’intérêt général. Il faut corriger cette perception. Quelles seraient vos priorités ?

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Il faut se concentrer sur les grandes questions : l’approfondissement de l’Union économique et monétaire, le juste équilibre entre sérieux budgétaire et croissance, et le développement de notre industrie numérique. S’y ajoutent l’action extérieure et la défense commune, la réorganisation de nos relations avec nos voisins de l’Est. Les citoyens européens veulent dans leur très grande majorité que l’Union européenne exprime une même vue sur les grands sujets de politique internationale. Ca n’a pas toujours été le cas ces dernières semaines à propos de l’Ukraine... Tous les Européens sont pourtant d’accord : nous ne pouvons pas abandonner l’Ukraine. Il faut protéger son intégrité territoriale. La Crimée fait partie de son territoire. Tout référendum pour la rattacher à la Russie est contraire à la Constitution du pays et aux règles de droit international. L’Ukraine démontre au passage toute la validité du projet européen. Vers qui pourrait-elle se tourner si l’Union européenne n’existait pas ? L’Europe et l’union monétaire constituent pour elle un espace de stabilité et de solidarité. La crise de l’euro est elle finie ? Il serait hasardeux de le proclamer. Nous sommes sur le bon chemin, mais des montagnes sont encore à franchir. Que manque-t-il ? L’Union bancaire constitue la priorité du moment. Il faut de surcroît renforcer encore la coordination des politiques économiques. C’est essentiel. Matteo Renzi en Italie vient d’annoncer des baisses massives d’impôts. Son pari peut-il marcher ? Je suis toujours très inquiet quand un gouvernement prend des initiatives qui n’ont pas été concertées au sein de l’eurozone ou au moins avec la Commission européenne. Plaidez-vous toujours pour des obligations européennes ? J’avais lancé cette idée, elle me reste chère. C’est une perspective de long terme qu’il serait extravagant de vouloir discuter en cas de renégociation prochaine des traités. Les socialistes allemands aux mêmes ne l’ont pas retenu dans le programme de la grande coalition. Un nouveau traité est-il nécessaire? Une réforme des traités ne doit pas être exclue mais nous ne devons pas en préjuger. Très rapidement après la mise en place des nouvelles autorités européennes, nous devons faire le point sur la validité des instruments et sur la nécessité d’initiatives nouvelles. Il faudra renforcer un certain nombre d’exigences en matière de coordination des politiques économiques. Nous devons approfondir la gestion collective et solidaire de la monnaie unique. Cela passe aussi par le rapprochement de nos politiques fiscales. Aucun pays ne devrait être autorisé à pratiquer une concurrence déloyale dans ce domaine. Comment pouvez-vous être entendu sur ce plan après avoir dirigé un pays considéré comme un paradis fiscal ? Le Parti socialiste français m’a vilipendé, me présentant comme un grand défenseur du secret bancaire luxembourgeois. Cela me vexe et me contrarie. J’ai beaucoup fait pour harmoniser les taux de TVA et d’accises. Nous avons aussi soutenu les travaux destinés à encadrer la fiscalité de l’épargne. Nous avons opté pour la mise en place d’une retenue à la source, susceptible de sauvegarder le secret bancaire. Cette décision a été approuvé par nos partenaires et nous n’avons jamais été opposé à faire évoluer ce dispositif pour élargir son assiette ou passer à l’échange automatique d’informations. 130

Le bilan de la commission Barroso est il un atout ou un handicap pour le PPE ? La Commission est composée de treize commissaires PPE. Quinze ne proviennent donc pas de notre famille. Il est trompeur d’accuser la Commission de tout ce qui n’a pas réussi pour créditer les Etats des succès. Les institutions et les Etats ont une responsabilité commune. On ne peut pas faire avancer l’Europe sans les Etats. Quant à la Commission, elle doit rester le moteur du projet, la gardienne des traités et la fabrique des initiatives communes. Si le PPE devait arriver derrière les socialistes, pourriez-vous être candidat à un autre poste, comme la présidence du Conseil européen ou de l’Eurogroupe ? La présidence du Conseil n’est pas à l’ordre du jour. Quant à l’Eurogroupe, j’ai été le premier à proposer une présidence à plein temps pour ce poste très exposé. Mais après huit ans à sa tête, je n’ai pas envie de rempiler. Propos recueillis à Bruxelles par Philippe Ricard http://unioneuropeenne.blog.lemonde.fr/2014/03/17/juncker-le-prochain-president-de- la-commission-sera-soit-schulz-soit-moi/

ft. com World Europe Brussels Last updated:June 24, 2014 5:28 pm Italy’s Matteo Renzi likens EU to ‘old boring aunt’ By Giulia Segreti and Guy Dinmore in Rome

©Reuters Matteo Renzi sets out his vision for Europe in a speech to parliament in Rome The EU has to change course and stop behaving like an “old boring aunt”, Matteo Renzi, Italy’s centre-left prime minister, has told parliament in Rome, warning

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“conservatives” and Jean-Claude Juncker that economic policies have to focus on growth. Enjoying his status as leader of the party that won the most votes in last month’s European Parliament elections, Mr Renzi set out his vision for the EU in a speech lasting nearly an hour. It was replete with colourful metaphors but short on specifics. More ON THIS TOPIC// Ripples of Venice scandal spread/ Global Insight Corruption déjà vu/ Italy’s Northern League changes tack/ Italy’s Grillo maintains protest message IN EUROPE// Spanish princess faces trial/ US considers further Russia sanctions/ Putin moves to lift Ukraine troop mandate/ Le Pen fails to form EU political group “Those who imagine that the gap in Europe is filled with the nomination of Juncker are living on Mars,” said Mr Renzi, seemingly reaffirming Italy’s support for the former Luxembourg prime minister as the next head of the European Commission, while warning a new direction is needed. “A technocratic cut and paste” was not enough to heal the wounds in Europe’s institutions, he said. Italy’s Democratic party won a landslide victory on a programme of pro-European reforms that established Mr Renzi as a leading voice among centre-left leaders on the international stage and strengthened his hand in demanding that Germany accept more “flexibility” in EU fiscal rules. It also gave the former mayor of Florence the legitimacy he lacked at home after being elevated unelected to prime minister through a party coup. Reinforcing his call for a new direction from Brussels, Mr Renzi urged Herman Van Rompuy, the European Council president mediating in the dispute over top positions, to ensure that the next president of the commission be a “catalyst for change”. FT Video Managing Italian political risk

February 2014: Matteo Renzi is the new prime minister of Italy. Judging by the past 68 years, his tenure will be more short-lived than the two-year average of football managers. James Mackintosh, investment editor, looks at why markets shrugged off the change “The European elections showed a widespread and still unanswered demand for change. The choice is ours. We can turn a blind eye and let this demand turn sour, fuelling anti- European, even xenophobic sentiment. Or we can address the underlying needs,” Mr Renzi said in a letter to Mr Van Rompuy. Mr Renzi made clear that fiscal flexibility, jobs, growth and immigration would be his priorities when Italy takes over the rotating six-month presidency of the EU next week. Italy would keep to its 3 per cent deficit limit set by Brussels, Mr Renzi said, and made clear the rules of the stability pact were not up for discussion. But he said there were “different ways” of dealing with these rules, hinting at Italy’s demands for more flexibility – a theme dominating Italy’s front pages. He railed against what he called the “shopping list” of recommendations set by the commission, which he compared with “an old boring aunt telling us what to do”.

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But any hope of substantially reducing its debt-to-GDP ratio, which is about 136 per cent and the second-highest in the eurozone after Greece, depends on an economic recovery that is still eluding Italy, which has posted only one quarter of marginal growth in nearly three years. The head of Germany’s central bank on Tuesday attacked the push by European centre- left leaders, led by Mr Renzi, to loosen the EU’s budget deficit rules. Brussels blog

Notes on the EU’s capital: Our Brussels blog looks at the EU’s foreign and economic policies Jens Weidmann, Bundesbank president, told the Süddeutsche Zeitung daily that the rules, introduced at the height of the eurozone’s sovereign debt crisis, needed to be strengthened rather than weakened. “The fiscal rules have not, under any stretch of the imagination, proven to be particularly tough,” he said, adding that it was “sobering” that the waning of market pressure on member states to reform their economies had so quickly been followed by a chorus of political voices calling for the rules to be relaxed. Mr Weidmann hit out at the “particularly loud” calls for reform emanating from Paris, where French president François Hollande backs Mr Renzi’s push. “There the deficit has exceeded 3 per cent in nine out of the 15 years since monetary union was established,” Mr Weidmann said. “This is anything but an ‘austerity diktat’.” Additional reporting by Claire Jones http://www.ft.com/intl/cms/s/0/dbc4b624-fb80-11e3-9a03- 00144feab7de.html#axzz35eEkdq1d

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ft.com comment Columnists June 24, 2014 3:37 pm Defend Argentina from the vultures

By Martin Wolf A creditor paid more to take on the risk of a default cannot then be surprised by it

Not far from the London offices of the Financial Times was the Marshalsea prison where debtors used to be sent. In the 18th century, more than half of London’s prisoners were incarcerated for their undischarged debt. The moral hazard Taliban of the day insisted that such harsh penalties were necessary. Then, in 1869, imprisonment for debt was abolished and bankruptcy introduced. Both economy and society survived. Things sometimes go wrong. Sometimes this is due to bad luck and sometimes to irresponsibility. But society needs a way to allow people to start over again. This is why we have bankruptcy. Indeed, we allow the most important private actors in our economies – companies – to enjoy limited liability. This lets shareholders walk away from their companies’ debts unscathed. That idea, too, was condemned as a licence to irresponsibility when introduced. Limited liability does bring problems, notably in highly leveraged businesses (such as banking). The ease with which US corporations can walk away from their creditors is breathtaking. But this is better than unlimited liability. More ON THIS STORY// Argentina turns to talks to avoid default/ Fernández will ‘negotiate’ with holdouts/ Letter Argentina can woo NML Capital/ Ruling leaves Argentina in a quandary/ Argentina backed in holdout creditor case

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ON THIS TOPIC// Argentina case shifts power to creditors/ Argentina dispute fails to deter investors/ Global Insight Argentina in game of chicken over debt/ Editorial Ending Argentina bond battle MARTIN WOLF// Effects of climate fix/ UK has to be in or out of EU/ Events that shaped our world/ Martin Wolf Another rabbit from the hat A similar logic applies to countries. Sometimes their governments borrow more than they turn out to be able to afford. If they have borrowed in domestic currency, they can inflate their debt away. But if they have borrowed in foreign currency, that possibility disappears. Usually, it is countries with a history of fiscal irresponsibility that find themselves obliged to borrow in foreign currencies. The eurozone has put its members in the same position: for each government, the euro is close to being a foreign currency. When the costs of servicing such debts become too high, then restructuring – default – becomes necessary. As Carmen Reinhart and Kenneth Rogoff of Harvard University showed in This Time is Different, this is an old story. As I argued at the time, Argentina found itself in this position at the turn of the century. It was difficult to feel much sympathy for the country, which suffered from chronic mismanagement before its default in December 2001 and was to suffer yet more thereafter. But it had become impossible to service its public debt of $132bn at tolerable cost. Moreover, creditors had been rewarded for the possibility of default. Even at its lowest point, in September 1997, the spread of Argentine dollar bonds over US Treasuries was close to three percentage points. A creditor compensated for the risk of a default cannot be surprised by it. The solution is portfolio diversification. While the principle of sovereign debt restructuring is compelling, in practice it is difficult. No court can seize and then liquidate a country’s entire assets. This legal limbo creates two opposing dangers: the first is that it is too easy for a country to walk away from its debts; the second is that it is too hard. The Argentine story illustrates both: confronted with an intransigent government, holders of 93 per cent of defaulted debt accepted exchanges for debt with a hugely reduced face value; but “holdouts”, who reject such an exchange, have blocked a clean resolution. The mess has lasted more than 12 years from the default. If Argentina is forced to pay holdouts in full, the price will be borne by Argentines As first deputy managing director of the International Monetary Fund, Anne Krueger advanced a proposal for a sovereign debt restructuring mechanism in 2002. She argued that the restructuring process could be delayed or blocked if some creditors were able to hold out for full payment. Her ideas were more supranational than governments – above all, the US – could bear. But “collective action clauses” were at least introduced. Yet such clauses might not have prevented the success of holdouts over Argentina, led by Paul Singer of Elliott Management. As the IMF recently noted, these clauses “typically only bind holders of the same issuance”. A holdout creditor can “neutralise the operation of such clauses” if they secure a blocking position, normally more than 25 per cent. Moreover, adds the IMF, US courts have interpreted a “boiler plate provision” of these contracts (the so-called pari passu clause) as requiring a sovereign debtor to make full payment on a defaulted claim if it makes any payments on restructured bonds. In addition, the US courts will force financial intermediaries to help creditors obtain hold

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of the sovereign’s assets. All this will make restructurings harder. Why should creditors accept an exchange for instruments with reduced value in future? I am no lawyer, but to me the idea of equal treatment means treating like cases in the same way. Yet creditors who have accepted exchanges and holdouts are not like cases. To force debtors to treat them equally seems wrong. Moreover, the argument that holdouts are helping Argentines by punishing government corruption is absurd. It is up to Argentines to choose the government they desire. Worse, if Argentina is forced to pay holdouts in full, the price will be borne by Argentines. This is extortion backed by the US judiciary. The immediate issue is how Argentina might settle these cases. The options – paying the holdouts, reaching a deal with them, transferring restructured debt into domestic law and outright default – look costly, humiliating, difficult or damaging. Worse are the longer-term implications for debt restructurings. One possibility is to eliminate the pari passu clause. Another is to introduce stronger collective action clauses, particularly ones that cover all outstanding instruments. Another is to shift issuance from New York. But all three would apply only in future. Another possibility would be to amend US law. A final possibility, as José Antonio Ocampo of Columbia University notes, is to revive the idea of a global mechanism. These last two options look very unlikely. Yet in a world of global capital flows, a workable mechanism for restructuring sovereign debt is not an optional extra. It is possible that Argentina is an exceptional case. It is more likely that the interpretation of the pari passu clause and the ability to pursue assets will now make it more difficult to restructure debt. A world in which the choice for sovereigns and their creditors is between full payment and absolute non- payment would be as bad as one in which debtors had to choose between starvation and prison. A better way must now be found. http://www.ft.com/intl/cms/s/0/2bfc9a52-f8a3-11e3-befc- 00144feabdc0.html#axzz35eEkdq1d High quality global journalism requires investment. Please share this article with others using the link below, do not cut & paste the article. See our Ts&Cs and Copyright Policy for more detail. Email [email protected] to buy additional rights. http://www.ft.com/cms/s/0/ff7c3086-f8a3-11e3-befc- 00144feabdc0.html#ixzz35eFgRKtn

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The U.S. Supreme Court building in Washington. (Courtesy Reuters) Hedge Fund vs. Sovereign How U.S. Courts Are Upending International Finance By FELIX SALMON, senior editor at Fusion. June 24, 2014 There aren’t many institutions powerful enough to bring a sovereign nation to its knees. Most of those that are wield their power with great care; the rest are dangerous fundamentalists. Last week, the U.S. Supreme Court placed itself -- and the rest of the U.S. federal judicial system -- squarely in the latter camp when it refused to accept an appeal by Argentina against a lower-court decision. The consequences are certain to be dreadful for Argentina. More broadly, the ruling will make it more difficult for countries to free themselves from the burden of over-indebtedness. It will be very bad for international capital markets. Oh -- and it will also diminish national sovereignty. The case involved Argentina and a group of so-called vulture funds, led by the deep- pocketed and highly litigious hedge fund Elliott Associates, which was demanding repayment in full on old Argentine debt. Elliott had first come to broad public attention in 2000, when it brought -- and won -- a similar case against Peru. That unprecedented victory against a sovereign government, although worth a mere $90 million, so deeply shocked the international financial community that it prompted the International Monetary Fund to undertake a messy and protracted attempt to create a brand-new sovereign bankruptcy court. The Argentina case is much, much bigger -- Argentina owes Elliott over a billion dollars. The total amount that it owes “holdout creditors,” as the vulture funds are more formally known, is some $15 billion. Given that other holdout firms will immediately demand any terms awarded to Elliott, Argentina is not lying when it says that it simply can’t afford to do what the U.S. courts are demanding of it -- which is to pay all the holdouts in full. Nor, of course, would it ever want to. Argentina defaulted on all of its foreign bonds in 2002, at the end of a depression that saw its economy shrink by 28 percent, its currency devalue enormously, and millions of its citizens lose their jobs and go hungry. At the time, it was the largest debt default the world had ever seen. (Lehman Brothers would eventually break that record.) Argentina’s foreign debt went unpaid until 2005, when the country offered its creditors a deal: Give us your old defaulted bonds and we’ll give you new bonds in return, with a lower face value. You should do that, because we’ll actually pay the money we owe on the new bonds. (This also hinted that it would remain in default on the old bonds.) Argentina was true to its word, and, after a second bond swap was finished in 2010, some 93 percent of the holders of the original debt had swapped it out for what are

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known as “exchange bonds.” The swap was coercive, to be sure: bondholders didn’t have much say in the matter, beyond the choice of whether or not to participate. But that’s the way of sovereign debt. If a sovereign defaults, there’s not much creditors can do to force it to pay up. That’s what “sovereign” means. Traditionally, then, most bondholders have simply accepted any exchange offer they’re given. And, in turn, such exchanges have become an established means by which countries restructure their debts to avoid remaining in default indefinitely. The case in New York -- the one that made it all the way to the Supreme Court -- was brought by bondholders that didn’t participate in the exchange. They originally bought their debt at a deep discount, and they knew how to apply past-due compound interest calculations to make the face value of the defaulted debt balloon into the billions. They knew that it wouldn’t be easy to get paid in full, but if they managed it they would have scored one of the biggest home runs in hedge-fund history. Thus did the cat-and-mouse game between Elliott and Argentina begin: Elliott would try to seize Argentine assets, and Argentina would try to keep them out of Elliott’s reach. At one point, an Argentine naval sailing vessel, the Libertad, was confiscated by local authorities in Ghana, with the intention that it be handed over to Elliott. The ship was released only after a ruling from the International Tribunal for the Law of the Sea. But behind all the legal shenanigans was a serious debate about sovereign bankruptcy, or, rather, about the fact that there’s no such thing as sovereign bankruptcy. Countries do not default lightly: doing so nearly always results in the government falling, and in the country being unable to borrow money abroad for many years to come. Since most countries run deficits, being able to borrow money is extremely important. If a country does default on debts, then it needs some way to cure that default, reenter the international financial system, and give itself and its companies the ability to fund themselves with debt. Because countries can’t declare bankruptcy, exchange offers are the next best thing. But for those to work, a debtor country needs to be able to pay the exchange bondholders without paying the holdouts. Otherwise, no one would ever participate in an exchange, and no country could ever restructure its debts. This, then, is why Brazil, France, Mexico, and the United States supported Argentina in the Elliott case. None of them had much sympathy for Argentina itself, or its government. But they did have a vested interest in maintaining a sovereign’s right to pay one group of creditors without paying another. Indeed, it’s something that anyone who found himself in a similar situation might do: he might choose to pay his rent even if that means falling behind on credit card payments, for instance. But this is where U.S. courts started getting creative. For years, Judge Thomas Griesa had levied increasingly strict rulings against Argentina, which Argentina had ignored. After many years of fruitless litigation, Griesa turned to a nuclear option. He ginned up a new violation by Argentina, which was embedded in something called the pari passu clause. The pari passu clause is a piece of hoary financial boilerplate that means absolutely nothing in a sovereign context. The clause, which said that Argentina’s bonds would “rank at least equally” with all its other indebtedness, makes sense only for debtors who can file for bankruptcy. Yet Griesa ruled that Argentina was in violation of pari passu. That ruling, in and of itself, was no big deal. Argentina was in violation of hundreds if not thousands of contractual obligations, and one more was hardly going to make much of a difference. But in this case, Griesa came up with a brand-new remedy to cure the newly discovered violation. 138

And the remedy, much more than the violation itself, is what will end up transforming the world of sovereign debt. Normally, when a borrower violates a contractual obligation, a judge will hand down a judgment against that borrower. In this case, however, Griesa went after the bondholders who had accepted 30 cents on the dollar for restructured Argentine debt. He told every other agent in the payments chain, up to and including the trustee for the exchange bondholders, that Argentina was not allowed to pay them until Elliott had been paid in full. If the trustee or anybody else helped Argentina pay its exchange bondholders, then Griesa would find them in contempt of court, assuming that Elliott had not been paid at that time. That order was stayed pending appeal, but it is now in full effect. Make no mistake: the innocent are being punished. The exchange bondholders have done nothing wrong, and there is no way that they’re going to get their payment in full and on time, as Argentina would like. But the ruling goes well beyond punishing the innocent. It also turns the natural order of debt on its head. It used to be that having a bond was good but that having a judgment was much better. Now, however, it’s the other way around: judgments will get you nowhere, while bonds, if they have a pari passu clause, can make you all-powerful. There’s also no logic to how this new system of jurisprudence should be enforced. The remedy seems to be available, more or less randomly, only to bondholders with a certain clause in their contracts. Worse, it actually discourages countries from making any payments at all, even if they’re both willing and able to do so, unless they can make all the payments they’re obliged to make. Griesa’s ruling was the act of an exasperated judge at the end of his tether. And, in truth, he deserves a certain amount of sympathy: he has had the gruesome and thankless task, over the past decade, of overseeing dozens of lawsuits against Argentina. But once he had ruled, it became the job of the appeals courts -- first the Second Circuit, and then the Supreme Court -- to grapple with what he had done and to think hard about the implications. But both of them ducked those questions. Griesa, they said, was within his rights to rule as he had done -- true enough. And Argentina should be required, under New York law, to pay its debts -- that’s true, too. But that leaves open the questions of sovereign immunity, the future of sovereign debt restructuring, and the future of New York as a financial center. This is where the Supreme Court's ruling comes in. On June 16, it handed down a 16- page decision in a parallel and much less important case, also finding against Argentina. In that ruling, Justice Antonin Scalia explained that, once upon a time, the Supreme Court would defer to the executive branch whenever the time came to make decisions involving judicial power over sovereign states. And invariably the executive branch would seek to hold foreign sovereigns immune from U.S. judicial proceedings. The result, says Scalia, was “bedlam,” which was “abated” only by the passage of the Foreign Sovereign Immunities Act in 1976. For the past 38 years, such questions have no longer been up to the U.S. State Department, or even the president; they’ve been entirely under the purview of the courts. “Any sort of immunity defense made by a foreign sovereign in an American court must stand on the Act’s text,” he writes. “Or it must fall.”

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What Scalia is saying is that it’s not his job to worry about the fate of international bond markets, or the sanctity of concepts such as sovereign immunity. He can look only within the four corners of a legal document, and see what he finds there. Nothing else matters. Which is basically what the Second Circuit said, even though it couldn’t entirely duck the sovereign immunity question -- it said that “further guidance from the Supreme Court” could settle that question more decisively. Yet, so far, the Supreme Court has remained silent. The result is, to use Scalia’s term, bedlam. Argentina wants to pay the exchange bondholders, but it can’t. Argentina doesn’t want to pay Elliott, but it has to. It is stuck on the horns of a dilemma, where every possible course of action is a bad one. So what should Argentina do? It has said that it will negotiate with Elliott, but given how stubborn both sides are, it would be astonishing were the negotiations to bear fruit. Argentina has also said that it will not default on the exchange bondholders -- although there’s a case to be made that simply tendering payment to the Bank of New York, even if that payment is refused, is technically enough to avoid default. (Which of course would come as cold comfort to the unpaid bondholders.) There has also been talk of trying to do some kind of new bond swap, where exchange bondholders could swap their paper again for new bonds issued in Argentina, away from the reach of U.S. courts. That seems extremely unlikely to happen, though, since only the trustee can reliably identify who the bondholders are, and the trustee would never cooperate with such a plan without Griesa’s permission. There is one other possibility. It’s not a pleasant one -- not for exchange bondholders, not for Argentina, not for Griesa, and certainly not for Elliott. But it might just be the least unpleasant option. In the world of public corporations, it has become popular to buy back stock instead of issuing a dividend: shareholders often have tax reasons for preferring buybacks to dividends, and companies are following their preferences. Bond issuers don’t have that option: they’re contractually obliged to make coupon payments. But once a bond has defaulted, it is possible to get a bit more imaginative. And if Argentina wanted to continue to funnel money toward the exchange bondholders, one way of effectively doing so would be to simply buy up those bonds on the secondary market. Argentina could simply take the money that it would otherwise have spent on coupons and spend it instead of buying newly defaulted exchange bonds. Or it could go further, and attempt some kind of full-fledged de facto bond exchange. Argentina will certainly continue to issue local debt, including local bonds pegged to the dollar, just as it has done for many years. So maybe it could step up that local debt issuance, and start using the proceeds to buy back its defaulted exchange bonds. The country’s total indebtedness would not go up; if anything, thanks to the defaulted bonds trading at a discount, it might well go down. But the longer Argentina conducts that trade -- the more local debt it issued, and the more exchange bonds it bought back on the secondary market -- the closer it would come to much the same outcome as if it had simply swapped the exchange bonds for local bonds in a big formal exchange offer. There would be serious costs to such a strategy. For one thing, Argentina would be cementing its status as a financial-markets untouchable: it would be going backward rather than forward. But at least it wouldn’t have to make the politically disastrous decision to pay Elliott -- and the other holdout creditors -- billions of dollars it can’t afford. 140

And if anybody started criticizing the country for being in default on the exchange bonds, Argentina could always say, quite honestly, that it has both the ability and the willingness to pay -- and that the only reason its bondholders aren’t getting paid is that the U.S. courts won’t let them be paid. Both the Second Circuit and the Supreme Court had every opportunity to avert this disaster, and instead they punted. They are the ones who should be held responsible for the fallout. Enjoy this free article from Foreign Affairs All visitors get access to one full-length article each month. Register now to get three more free articles and other special offers. registerHave an account? Log in here. ON THIS TOPIC Essay, May/Jun 2006 The Return of Saving Martin Feldstein THE U.S. SAVINGS RATE AND THE GLOBAL ECONOMY The savings rate of American households has been declining for more than a decade and recently turned negative. This decrease has dramatically reduced total national savings despite a rise in corporate saving. In 2003 and 2004, the combined net ... Read Review Essay, Sep/Oct 2007 A Raw Deal Charles W. Calomiris William Graham Sumner, who at the turn of the twentieth century practically invented the field of political economy in the United States, was the first to coin the phrase "the forgotten man." It was his term to describe the citizen who loses out as a result of government interventions that favor ... Read Essay, Jan/Feb 2008 Reconsidering Revaluation David D. Hale and Lyric Hughes Hale China's economy has grown dramatically in the last decade: it is more than twice as large as it was ten years ago. This spectacular rise means that Beijing can influence the global economy today in ways that would have been unimaginable in the 1990s -- a development that has led to widespread ... http://www.foreignaffairs.com/articles/141588/felix-salmon/hedge-fund-vs-sovereign

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06/24/2014 10:05 AM Queen's Quandary Chancellor Merkel's Power Erodes in Europe By SPIEGEL Staff For years, German Chancellor Angela Merkel was the strongest politician in the European Union. Lately, her hold on power has become weaker -- and one of the greatest challenges is coming from within her own government.

DPA German Chancellor Angela Merkel has long held a firm grip on the reins of power in the European Union. But lately, opposition to her austerity policies has been growing -- and her own vice chancellor, Sigmar Gabriel, is leading the way. Not long ago, German Vice Chancellor Sigmar Gabriel was traveling in southern France with a small group of other Social Democrats when they stopped off at a countryside restaurant for a bite to eat. The welcome they received was not exactly warm: "If you Germans keep going like this, you are going to ruin the EU," the restaurant owner told them. Taken aback, Gabriel mumbled under his breath that he didn't really want to know who the woman had voted for in the recent European Parliament elections. And soon, the group was engaged in a lively discussion about the degree to which France's right-wing Front National party had benefited from the austerity policies that Germany had imposed on many euro-zone member states during the common currency crisis. One day after the mealtime debate, Gabriel, who is also Germany's economy minister, spoke to journalists during a tour of the Airbus facility in Toulouse. European policies have to be revisited, Gabriel said. "The focus on pure austerity policies has failed," he claimed. The reporters couldn't believe their ears. Did he really just say that? Is Gabriel in the process of turning away from the highly touted Stability Pact after years of backing 142

German Chancellor Angela Merkel's euro-crisis strategy? Is he trying to pick a fight with Europe's austerity queen? Gabriel's comment was just the latest indication that Merkel's solid hold on the reins of power in Europe may slowly be weakening. After years of being the de facto leader of Europe, largely a function of Germany's relatively good economic health even as the Continent's economy crumbled around it, Merkel is now losing traction on a number of issues. Indeed, with her premature approval of lead candidate status for Jean-Claude Juncker in the European election campaign, she may have opened the door for her own gradual loss of power. The assault on Merkel is coming from three flanks. First off, she is facing pressure from her rivals inside of Europe. The governments in Rome and Paris have long believed that Merkel is too dominant and that she is pushing Europe in the wrong direction. But now, the chancellor is also losing the support of countries that once favored her course. Indeed, when EU leaders gather in Brussels, there is one issue that unites them all, regardless of their party affiliation: They believe that Merkel is too powerful. Merkel's critics, secondly, will soon have an ally at the head of the European Commission. As the situation currently stands, it seems probable that Jean-Claude Juncker will become president of the EU's executive body. Officially, Merkel supports the center-right politician from Luxembourg. But when it comes to austerity in Europe and financial policy, Juncker is far to the left of the German chancellor. A Miserly Bookkeeper The third attack is coming from within her own government. Merkel's authority in Brussels has been partly due to her complete lack of rivals in Germany. She has, of course, always had critics in German parliament, but never a powerful adversary. Now, though, her own vice chancellor, Sigmar Gabriel -- leader of the center-left Social Democrats, her coalition partners -- seems to be turning on her. He is seeking to present himself as a man who wants to hold Europe together, and is making Merkel look like a miserly bookkeeper. Gabriel's plan is not without risk. Merkel's team has already begun quietly accusing Gabriel of acting against Germany's best interests. And with the smooth functioning of her government dependent on a strong relationship between her and her deputy, the Merkel-Gabriel spat could ultimately become a threat to the stability of the chancellor's coalition. Gabriel is aware of the dangers. But he believes that the advance of European right- wing populists can only be stopped if the economic situation in crisis-torn EU countries improves quickly -- and he's more than happy to help hold the queen of Europe in check. That also explains why he is prepared to form alliances with those who would like to see Merkel's reign come to an end, François Hollande above all. The French president has undergone a shocking about-face during his two years in office, from a vociferous defender of Socialist values to an energetic supporter of economic reform. On one point, however, he has remained constant: He believes the Stability Pact, which imposes strict rules on EU member-states' budgets, is nonsense. Internally, Hollande and his new prime minister Manuel Valls point to the reform program they have introduced, which aims to relieve French firms to the tune of €40 billion ($54 billion). But they also realize that, with the right-wing Front National

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having received 25 percent of the vote in the European election in May, they cannot return to business as usual. Economic growth is paramount, which is why Paris is aiming for a more "flexible" approach to the rules of the Stability Pact. Hollande finds Merkel's focus on austerity repugnant and would like to see investments in energy, research and technology excluded from the calculations that determine a country's budget deficit. Gabriel agrees. For Socialist leader Hollande, a weakening of the Stability Pact would be a victory over "neo-liberal" Germany and it could also help him push his reform package through parliament. Internal Debate in Berlin Merkel has rejected the proposal out of hand, but the French have not been deterred. Government sources in Paris say they have the impression that an internal debate is underway within the German government. On Saturday, center-left leaders from a number of European countries met in Paris -- in a gathering initiated by Gabriel -- and agreed that the rules of Stability Pact should be implemented more flexibly to support growth. Even worse for Merkel, she now faces a growing number of opponents within the EU. When the Dutch, for example, slipped into recession two years ago, they suddenly softened their focus on austerity. Holland's Finance Minister Jeroen Dijsselbloem is also the head of the Euro Group, which puts him in something of an intermediary role between pro-austerity countries such as Germany and others that would like to see the rules relaxed. Finland too has backed away from its earlier pro-austerity position. But Merkel's most dangerous rival is Matteo Renzi. In contrast to Hollande, the Italian prime minister does not have a reputation for being an old-school Socialist. He won the European elections in Italy despite having announced his intention to push through reforms. For the moment, though, the reform package -- as is the case in France -- has yet to be passed. Italy faces a number of problems: The country's sovereign debt is a whopping 133 percent of its gross domestic product and unemployment stands at 12.6 percent. "Italy has for too long postponed much-needed structural reforms," the European Commission wrote in a March report on the country. Renzi hopes that weakening the Stability Pact will give him the flexibility needed to rapidly address his country's many issues, but Merkel is adamant about preventing him from doing so. She believes that the Fiscal Pact -- the 2012 agreement which strengthens many of the Stability Pact provisions -- is one of the few meaningful consequences Europe has drawn from its debt and currency crisis. She only recently reiterated her standpoint to Juncker. Merkel, no doubt, felt it was necessary to remind Juncker about where she stood. During the campaign, Juncker was careful to hew to the austerity message that guided Europe through the euro crisis, in part to avoid a conflict with Berlin. But back in 2003, when he was still prime minister of Luxembourg and able to speak freely, he said, "There are many points in which the Stability Pact goes against commons sense." It was also Juncker who helped German Chancellor Gerhard Schröder and French President Jacques Chirac weaken the Stability Pact back in 2002. Many view those years -- when both Germany and France were allowed to blithely ignore the pact's deficit rules -- as a key milepost on the path to the Continent's current problems. 144

'Germany Will Pay' Merkel hasn't forgotten. Had it been up to her, the European center-right group, to which her Christian Democrats belong, would never have chosen Juncker as its lead candidate for the May elections. But when the decisive moment came, she was unable to block his appointment -- a mistake she quickly regretted. She even found fault with his campaign posters, emblazoned with the word "Solidarity." From her perspective, he might as well have written: "Germany Will Pay the Bill." But if Merkel can't block Juncker, she at least wants to fence him as much as she can. Thus far, the European Council -- made up of the 28 EU leaders -- has merely nominated the European Commission president. The European Parliament still needs to confirm the position. But this time around, Merkel wants to have a significant say in the governing program that will guide the Commission for the next five years. She especially wants to strengthen the domestic EU market and improve competitiveness -- in a nod to southern Europeans, she is also emphasizing improved growth policies. Yet it still isn't clear if the EU summit will be able to come up with a majority that will support of Juncker. He has plenty of opponents and they have been wary of showing their hands. Merkel's advisors believe that Hungarian Prime Minister Viktor Orbán could abstain in the end, despite having said he will vote no. British Prime Minister David Cameron, for his part, has been so vociferously opposed to Juncker that an abstention from him would be paramount to abdication. "The British would prefer to delay the decision again," said an advisor to German Foreign Minister Frank-Walter Steinmeier. Merkel wants to avoid an open break with Cameron. To be sure, he has often played a disruptive role in Brussels. But he has also been a reliable ally when it comes to thwarting Italy and France. And Merkel, at the moment, needs every ally she can get. Back in Berlin, Gabriel is a significant adversary when it comes to her European policies. Last Friday, her vice chancellor once again rushed to the defense of EU crisis countries. "Real reform in exchange for more time for deficit reduction -- I believe that would be a smart position," Gabriel said. "Germany's Agenda 2010 has shown that such a formula can lead to significant success," he added, in reference to the far-reaching package of labor market and welfare reforms passed by Schröder's government from 2003 to 2005. Gabriel also believes that the European Commission is inefficient and could completely revamping the body. "One commissioner speaks of re-industrialization while another says exactly the opposite," he complains. He imagines the creation of a steering committee made up of five to six commissioners which would be responsible for synchronizing the work of the 28-member executive. "A council answerable to the president could better coordinate the Commission's work," he says. 'There Are Limits' Gabriel has long found it objectionable that most Germans believe Merkel alone determines what happens in Brussels. He believes that the chancellor, as head of a coalition with the SPD, also has a responsibility to represent his party's positions at EU summits. That's one of the biggest reasons why he is currently trying to get more deeply involved.

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Gabriel's proposals have not been well received among Merkel's conservatives. Many Christian Democrats believe that the SPD has already been far too successful in pushing through its own policy proposals in Merkel's new government. Gender quotas, a retirement age of 63, minimum wage: All three policies come from the Social Democrats. Now, CDU strategists believe that Gabriel's most recent comments are an effort to tarnish Merkel's image as the queen of austerity. Gabriel should be careful of going too far, warns Steffen Kampeter, a CDU parliamentarian and state secretary in the Finance Ministry. "Were the SPD to demand that the CDU agree to changes to the Stability Pact, it would be akin to us withdrawing from the minimum wage compromise," he says. "There are limits." Internally, Gabriel says that he is not interested in starting a fight with Merkel. He instead sees himself as a liaison between the chancellor and all those countries for whom austerity is an unbearable burden. But of course, if Merkel's foreign policy aura dimmed, he wouldn't have any problems with that. Gabriel recently set up a working group in his Economy Ministry to develop a Europe strategy reflecting Social Democratic values. The focus, says one of the group members, is to find ways to promote growth in Europe. But it has also proven valuable in providing Gabriel with ammunition to counter Merkel. One slogan as already been established, insiders say: "The states cannot be allowed to save themselves to death." By Nikolaus Blome, Veit Medick, Peter Müller, René Pfister, Christian Reiermann, Mathieu von Rohr, Gregor Peter Schmitz, Christoph Schult and Gerald Traufetter Translated from the German by Charles Hawley URL: http://www.spiegel.de/international/germany/european-center-left-challenging-merkel-leadership- in-eu-a-976918.html Related SPIEGEL ONLINE links: • Commission Crusade: Cameron Outmaneuvered in Battle over Juncker (06/19/2014) http://www.spiegel.de/international/europe/cameron-and-juncker-fight-over-role-in-european- commission-a-975528.html • Trouble for Merkel: Berlin Divided in Spat over EU Commmission (06/07/2014) http://www.spiegel.de/international/europe/merkel-likely-to-seek-eu-compromise-with-london-a- 973962.html • Opinion: Europe's Juncker Bond (06/05/2014) http://www.spiegel.de/international/europe/opinion-why-germany-should-say-no-to-juncker-a- 973540.html • Cameron's Empty Threat: Britain Risks Losing an Ally in EU Feud (06/04/2014) http://www.spiegel.de/international/europe/cameron-risks-losing-merkel-as-ally-in-eu-feud-a- 973389.html • Ex-Premier Blair: 'British Understand the Folly of Leaving the EU' (06/03/2014) http://www.spiegel.de/international/europe/interview-with-former-british-premier-tony-blair-on-eu- and-reform-a-973226.html • Decision Time: Britain Must Choose Now If It Will Stay in Europe (06/03/2014) http://www.spiegel.de/international/europe/spiegel-editorial-argues-britain-must-determine-future-in- eu-a-972903.html • The Democratic Deficit: Europeans Vote, Merkel Decides (06/02/2014) http://www.spiegel.de/international/germany/power-struggle-europts-between-european-parliament- and-eu-leaders-a-972870.html

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06/24/2014 05:13 PM Russian Riddle EU Can't Agree on a Natural Gas Strategy By Frank Dohmen and Christoph Pauly European leaders agree that the Ukraine crisis has made natural gas supplies from Russia precarious. Yet they are divided over what to do about it. Poland wants a new European energy union, but others seem to be in no hurry. The flame last Tuesday was immense, rising some 200 meters (650 feet) into the air out of the natural gas pipeline named Brotherhood in eastern Ukraine. What caused the explosion remains a mystery. But it showed with shocking immediacy just how vulnerable Europe's energy supply has become as a result of the unrest in Ukraine. A day before the explosion, Russian energy giant Gazprom had announced that it would only continue supplying Ukraine if the country paid for deliveries in advance. Because about half of Russian gas headed for Western Europe flows through Ukraine, European leaders now have a crucial topic to discuss at their summit this week in Brussels: Will deliveries to EU member states be affected? At the same time, EU leaders are also wrangling over how to secure Europe's long-term natural gas supply. Polish Prime Minister Donald Tusk is determined to demand more solidarity from his European partners. Others too have taken up his proposal to create a so-called energy union to reduce Europe's dependence on Gazprom. But as so often happens in the EU, when it comes time to discuss the details, national interests diverge and friendships dissolve, particularly when money enters the picture. Tusk envisions the creation of a kind of purchasing syndicate that would negotiate with Russia. Poland is furious that it has to pay considerably more for natural gas than major German buyers. But German Minister of the Economy Sigmar Gabriel is skeptical. "There are good reasons why those are decisions made by the private economy," he said earlier this month at a meeting of EU energy ministers. Thus far, German suppliers like E.on or Wintershall have gotten along well with the Russians. They have long-term gas-supply contracts of up to 20 years with Russia, guaranteeing them lower prices. Unlawful Contracts? According to industry insiders, these old contracts are getting in the way of EU solidarity. A high-ranking E.on manager says that many such deals explicitly prohibit customers from re-selling the natural gas abroad. That means that the European Commission's plan calling for Western European countries to deliver gas to Eastern European countries in case of emergency is not currently workable. The EU executive is convinced that such clauses are against EU law. European Commissioner Joaquin Almunia has launched an investigation into Gazprom, partially as a result of the deals, and European Energy Commissioner Günther Oettinger is

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likewise skeptical. It would, he says, "be unlawful if the contracts stated that the gas can only be used in Germany." The financing of the planned energy union has also been a source of conflict. According to Commission calculations, about €200 billion would need to be invested by 2020 in order to upgrade pipelines and power lines so that a European single energy market could be created. The EU has only made €5.8 billion available thus far. EU member-states haven't even been able to agree on what measures must be taken before next winter. In the current version of the final summit communiqué, which is already being negotiated, there is only talk of strengthening "existing emergency and solidarity mechanisms," like natural gas storage. The Poles, on the other hand, are asking for concrete details, like who must deliver gas at what price and at which volume. The tone is getting sharper. "It's impossible," a Polish diplomat complains, "that we can't agree on something substantial in a crisis like this one." Translated from the German by Thomas Rogers URL: • http://www.spiegel.de/international/europe/european-leaders-cannot-agree-on- contingency-plan-for-natural-gas-a-976929.html Related SPIEGEL ONLINE links: • Ukraine: Cossacks Thought To Be Behind Observer Kidnappings (06/23/2014) http://www.spiegel.de/international/europe/cossacks-may-be-behind-kidnappings-of- osce-observers-in-ukraine-a-976830.html • German Defense Minister: 'Russia Has Destroyed a Massive Amount of Trust' (06/11/2014) http://www.spiegel.de/international/germany/interview-with-german-defense- minister-on-russia-and-global-conflicts-a-974569.html • Europe's New Status Quo: 'Ukraine Is Fighting Our Battle' (05/23/2014) http://www.spiegel.de/international/europe/experts-discuss-what-ukraine-crisis- means-for-future-of-europe-a-971032.html • Bad Banks for Nuclear Plants: Utilities Look to German Taxpayers (05/15/2014) http://www.spiegel.de/international/germany/utility-companies-want-public-trust-for- winding-down-nuclear-plants-a-969707.html • Cold Turkey: How Germany Could End Russian Gas Dependency (05/06/2014) http://www.spiegel.de/international/business/german-alternatives-to-russian-gas- numerous-but-pricey-a-967682.html

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Daily Morning Newsbriefing June 24, 2014 Don’t celebrate too early. Germany has yet to concede anything substantive on the fiscal rules We have noted the Italian press this morning celebrating the German “concession” of more flexibility in the fiscal rules. La Repubblica quotes Matteo Renzi as saying that the first obstacle had been removed. There was now an acknowledgement by Germany that flexibility was an issue to be discussed. Reuters reports of a draft proposals for the European Council calling for “differential budget consolidation” (whatever that means). The truth is, of course, that Angela Merkel has so far not conceded anything that is not already the law. There is already some flexibility in the fiscal rules, especially if you are below the hard deficit constraint of 3%. The CDU’s executive committee met to reaffirm their commitment to the existing rule and their opposition to any rule change. Merkel’s spokesman Steffen Seibert added that there was already an investment clause for countries with deficits below 3% to help with structural reforms. It was all a matter of individual application. Suddeutsche had a detailed report in yesterday’s edition - entitled “bending, not breaking” - about what happened at the Socialist leaders meeting over the weekend. Sigmar Gabriel, who himself has advocated a more flexible interpretation of the rules, has managed to persuade all Socialists heads that there can be no formal change in the rules – and has received support from the group for this German red line. In exchange, there should be two specific concessions by Germany. If a country were to fall short of the target by some €20bn (the sum Gerhard Schroder fell short in 2003) because of cuts in social security contributions, for example, than this should be “considered” (meaning excluded) in the deficit calculations. The article also quotes Martin Schulz as saying that Italy specifically needed easier access to EU investment, much of it is blocked because of complicated co-financing rules. Olli Rehn has defended the existing rules against criticisms that they were too complex. The reason for that is that they have become smarter. The eurozone after all started off with a simple 3% rule. There may be scope for simplification in the future, but warned against dumping a framework “with its counter-cyclical focus on the structural sustainability of public finances over the medium-term”. Much of this debate on rule change is hot air. The stability pact – once you stay below 3% - is already fairly flexible. The main problem with the rules is how they are applied in deep recessions – where they can act pro-cyclically if several countries pursue the rules at the same time. Our problem with the current debate is that there is a risk of continued pro-cyclicality as governments may reduce deficit reduction efforts during the 149

economic recovery. In Italy, for example, we have not seen any evidence of structural reforms that could be traded in as collateral for a temporary fiscal relaxation. With Juncker as Commission president, the other jobs are falling into place The Socialists leaders agreed that in return for supporting Jean-Claude Juncker, they want their own people for the two other big jobs – president of the EU Council and Perm Rep. The front runner for the Council presidency is Helle Thornig-Schmidt, who is also supported by Merkel, and who seems to enjoy broad support. On the Commission presidency, the European Council will take a formal vote – at the insistence of David Cameron who seems hell-bent to be demonstratively outvoted. The most informed article on the ensuing jobs carousel came from Corriere della Sera this morning, which reports that Matteo Renzi is pushing hard for Federica Mogherini, his foreign minister, as the Perm Rep to succeed Catherine Ashton. Italy is seeking one high profile appointment given the strong performance of the Italian PD in the European electiosn. Martin Schulz is to be re-elected president of the European Parliament – for a full term of five years. The article said the French would get Pierre Moscovici as the permanent head of the eurogroup. The most likely Commissioner for Economic Affairs will be Jyrki Katainen, the outgoing Finnish prime minister. The German Commissioner Günter Oettinger is to be reappointed in his current role as energy Commissioner. Perhaps someone can explain to us why Jyrki Katainen resigns as PM to take up Olli Rehn’s job? We know that Katainen has run the National Coalition for ten years, and that perhaps it was time for a change. But it is unusual for a former prime minister to settle for a job as a member of the Commission. Emerging details on Spain’s tax reform As more is known about the Spanish tax reform, the debate on its impact intensifies. El País reports that statutory severance payments will count as taxable income above €2,000 per year worked (Spanish labour law defines statutory severance proportionally to the number of years worked). This is one of the details of the reform that had been rumoured before. The paper also links to the draft tax law. Meanwhile, El Economista writes that the health care products (medical equipment, health care tools and pharmaceuticals) will be taken from the reduced VAT rate of 10% to the headline rate of 21%. The government had in a previous reform taken a number of other industries out of the reduced VAT rate. Finally, on income tax, El Blog Salmón argues that taxable income will expand to more than compensate the reduction in headline tax rates. For instance, the standard deduction on wage income is eliminated when there is a substantial source of other income. Nevertheless, a new deduction is introduced for the self-employed with low income. In addition, the reform makes non-taxable any capital gains in case a home is given up in payment of a delinquent mortgage by reason of insolvency, so that people whose home is repossessed are not saddled with unpayable tax bills as was happening in some cases.

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Naturally, in an economy where wages are being internally devalued and unemployment is at historical heights, it makes sense to shift the tax burden from wage to severance payments. Greek coalition agrees on part-privatisation of PPC Greek coalition parties reached a compromise on plans to partly privatise the Public Power Corporation (PPC), one of a list of the 12 prior actions the troika wants Greece to implement over the summer to secure two loan tranches worth €2bn. The reform bill foresees to split off about a third of PPC’s production capacity and clientele to form a smaller rival company that is then sold to a private investor. The legislation, which had been opposed by several Pasok deputies in regions where large power plants are located, is likely to be presented to MPs next week. The agreement includes concessions to employees, who will have their work contracts guaranteed for five years, and local residents, who will be prioritized in any recruitment, Kathimerini reports. IMF urges Ireland to stick to €2bn cuts The IMF’s departing representative in Ireland has cautioned the Irish government against reneging on its planned €2bn budget adjustment, because it runs a greater risk of missing its target of 3% deficit to GDP ratio for next year amid uncertain growth prospects. Doing the agreed €2bn this year, would provide greater proof that Ireland was sticking to its objectives and would “build further credibility” the Irish Times quotes Peter Breuer. This runs counter to Michael Noonan’s insistence that the important number in the consolidation process is the 3% deficit target, and that this can be achieved with adjustment of less than €2bn. Breuer also said in his last round up that mortgage arrears remained one of the biggest issues for the Irish state, noting that 27% of the loan book of Irish banks remained in the non-performing category. Compared with the IMF, the EU struck a softer tone in its report on Monday, saying that "while no concrete measures have been tabled, any plans to cut taxes or increase expenditure would need to be compatible with the agreed fiscal consolidation path," observes the Wall Street Journal. The forward looking indicator finally adjusts to the backward looking data We are quite amused to see how Markit explains the latest fall in its indicator – the actual numbers are not worth reporting. What has happened is that their index has given a wrong indication of the economic performance in Q1, and the subsequent downturn is nothing other than a case of a supposedly forward-looking indicator adjusting to backward-looking hard data. Markit’s chief economist gave us the hilarious comment that there was “concern that a second consecutive monthly fall in the index signals that the eurozone recovery is losing momentum.” This is blatant nonsense of course. The eurozone economy has had very little momentum in the first half of 2014. On the UK-German strategic relationship The British tendency to drool about strategic partners rises with their degree of isolation in the EU. We noted with some amusement Gideon Rachman’s FT column on the estrangement between David Cameron and Angela Merkel, which ended with the triumph of hope over experience that “in the longer term, they could yet form a fruitful alliance.”

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David Cameron is not the first man to complain that Merkel gave him assurances in private before changing her position. And while she has been keen to keep the UK inside the EU, her priority is to build effective governing coalitions in Brussels. This is not something she can do with Cameron. On German asset bubbles – or lack of There were two comments on asset bubbles in Germany today. One is Philip Plickert’s comment in Frankfurter Allgemeine, warning that the low interest rate policies would produce an asset price bubble in Germany. It was the tragedy of the euro that it started as a poisoned chalices to the periphery in the form of cheap money. Now the situation has reversed, as the core is subject to a bubble if interest rates were to remain at zero until the end of 2016. In his Spiegel column, Wolfgang Munchau makes two points. The first is that Germany does not have a property bubble. All that is happening is that German property price are slowly converging to eurozone average levels – and that is a good thing. The second point is that even if it were a bubble – which it is not – it would not matter a lot because it is not driven by lending. Credit expansion is virtually flat. Since Germany has the lowest house ownership rate in the EU, a bursting bubble would not have the same devastating effects on people with lower incomes as they would typically rent in Germany.

Eurozone Financial Data

10y spreads

Previous This Yesterday day Morning France 0.346 0.352 0.359 Italy 1.493 1.493 1.485 Spain 1.387 1.372 1.383 Portugal 2.202 2.214 2.225 Greece 4.678 4.659 4.70 Ireland 1.119 1.103 1.131 Belgium 0.466 0.470 0.484 Bund Yield 1.346 1.324 1.332

exchange rates This Previous morning Dollar 1.361 1.3595

Yen 138.700 138.5

Pound 0.799 0.7984

Swiss Franc 1.217 1.2168

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ZC Inflation Swaps previous last close

1 yr 0.75 0.74

2 yr 0.84 0.84

5 yr 1.23 1.23

10 yr 1.66 1.66

Eonia

23-Jun-14 0.03

20-Jun-14 0.03

19-Jun-14 0.01

18-Jun-14 0.02

OIS yield curve 1W 0.065 15M 0.047 2W 0.045 18M 0.051 3W 0.048 21M 0.080 1M 0.044 2Y 0.071 2M 0.051 3Y 0.156 3M 0.058 4Y 0.268 4M 0.059 5Y 0.399 5M 0.057 6Y 0.566 6M 0.054 7Y 0.741 7M 0.074 8Y 0.910 8M 0.072 9Y 1.068 9M 0.053 10Y 1.209 10M 0.055 15Y 1.713 11M 0.054 20Y 1.943 1Y 0.052 30Y 2.075

Euribor-OIS Spread previous last close

1 Week -2.914 -2.214

1 Month 3.386 3.886

3 Months 11.557 12.057

1 Year 39.271 38.971

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-06- 24.html?cHash=57a68906ffc39b17fb54359b90fc653e

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What a Drag: The Burden of Nonperforming Loans on Credit in the Euro Area Posted on June 23, 2014 by iMFdirect By Will Kerry, Jean Portier, Luigi Ruggerone and Constant Verkoren High and rising levels of nonperforming loans in the euro area have burdened bank balance sheets and acted as a drag on bank profits. Banks, striving to maintain provisions to cover bad loans, have had fewer earnings to build-up their capital buffers. This combination of weak profits and a decline in the quality of bank assets, resulting in tighter lending standards, has created challenging conditions when it comes to new lending. We took a closer look at this relationship and the policies to help fix the problem in our latest Global Financial Stability Report because credit is the grease that helps the economy function. The stock of nonperforming loans has doubled since the start of 2009 and now stands at more than €800 billion for the euro area as whole (see chart). Around 60 percent of these nonperforming loans stem from the corporate loan book.

Resolution of nonperforming loans There is a need to resolve this large stock of nonperforming loans clogging bank balance sheets. But there has not been much progress to date. The stock of nonperforming loans continues to rise, albeit at a slower pace than before, and banks have sold less than 6 % of the stock of nonperforming loans. Resolution has been hampered by three key factors.

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• Bank financial capacity—capital and provision buffers—to dispose of nonperforming loan portfolios given the current gap between what the loans were originally worth and what financial markets think they’re worth now. • Bank operational capacity to handle the quantity of bad assets. • Legal system capacity to process nonperforming assets—though a number of countries have recently introduced reforms to speed-up debt workouts—and relative immaturity of out-of-court restructuring frameworks in some countries. Cleanup of bank balance sheets Policymakers and banks have two other avenues they should pursue. First, banks need to clean up their balance sheets. The ongoing assessment of banks, conducted by the European Central Bank and the European Banking Authority is a first step in this process. The assessment needs to be credible, reliable and transparent, and should be followed by remedial actions that are implemented on a timely basis and clearly communicated to the market. In parallel, further actions are needed to fully address the constraints impeding the resolution of nonperforming assets: • Bank supervisors should continue to provide strong incentives for banks to maintain prudent provisioning levels, ensure that provisioning reflects forward-looking expected credit losses, and that a conservative approach is taken to collateral valuation, recovery rates and resolution time; • Banks that are overcapitalized for precautionary reasons need to use capital buffers to deal with losses; • Banks need a specialized capacity to deal with problem loans , either in-house or across different institutions; • Authorities should promote a liquid secondary market for nonperforming loans, for example through regulatory guidance on time limits for bad loan provisioning and retention or requirements to keep rigorous loan-servicing records and security documentation; • Legislators should reform legal frameworks—as has begun in a number of stressed euro area countries—and these should be resourced adequately to facilitate timely resolution of nonperforming assets; • Authorities should step-up efforts to increase debtor awareness of available restructuring tools; • Regulators should help to improve the transparency, timeliness, frequency and harmonization of bank and corporate balance sheets to aid the assessments of bank and corporate creditworthiness. New sources of credit Along with measures to facilitate an increase in corporate equity levels, including via targeted measures to encourage debt-for-equity swaps, authorities and markets could develop nonbank sources of credit, including bonds, further. However, officials need to ensure that effective regulation and supervision of nonbank entities should accompany these efforts to avoid building future problems.

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• Regulators should review existing constraints on nonbank long-term investors acting as lenders; • Officials should promote the listing of bonds by smaller firms; • Regulators should reconsider impediments to ‘safe’ securitization of loans • Official guarantees may be required, though governments should offer them in amounts consistent with the overall fiscal position of the economy, and structure them to prevent leaving guarantors with poor credits. Euro area policymakers face a daunting task in addressing the legacy debt burden to help complete the transition to an integrated financial system. Without significant policy efforts to address the burden of nonperforming loans, some economies may find they remain stuck in the mire of low profitability, low credit and low growth. http://blog-imfdirect.imf.org/2014/06/23/what-a-drag-the-burden-of-nonperforming- loans-on-credit-in-the-euro-area/

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Blogs Internacional Café Steiner En Café Steiner se recogen las mejores ideas y análisis sobre la actualidad internacional que se producen en los centros de pensamiento, instituciones, revistas y foros en Internet más influyentes. El buzón de Café Steiner ([email protected]) está abierto: esperamos los mejores argumentos, datos y análisis. ¿Cómo sería la desintegración de la UE? Por: José Ignacio Torreblanca| 23 de junio de 2014

Sabemos mucho sobre integración europea, pero nada sobre desintegración, nos advierte Jan Zielonka en su último libro “Is the EU doomed?” (¿Está la UE condenada?). Y si sabemos mucho sobre la primera y nada sobre la segunda es porque hasta ahora hemos vivido siempre con el supuesto de que la integración europea, aunque pudiera estancarse temporalmente, siempre progresaba. Pero según Zielonka, resulta absurdo no considerar la hipótesis de la desintegración, máxime cuando, como en los últimos años, hemos asistido a una explosión de tensiones entre los miembros. Que la consideremos no supone que sepamos mucho sobre cuán probable es o cómo ocurriría. Al fin y al cabo, nos recuerda Zielonka, el Imperio Austro-Húngaro, una de las construcciones políticas más absurdas e inviables que uno se pudiera imaginar, duró 600 años. Y la Unión Soviética, que parecía que iba 157

a durar eternamente, se vino abajo en unos pocos meses ante la sorpresa de todo el mundo. ¿Cómo sería entonces la desintegración de la UE y qué podría precipitarlo? Zielonka nos ofrece tres posibilidades. La primera sería el desbordamiento. No es una posibilidad teórica sino algo que hemos vivido de primera mano en los momentos álgidos de la crisis del euro. En ese supuesto, los líderes europeos podrían bien llegar demasiado tarde a salvar el euro o bien precipitar su caída con decisiones erróneas. Muy seguramente, dejar caer a Grecia, España o Italia hubiera tenido este efecto. La crisis de Chipre, con su torpe gestión a punto estuvo de provocar un pánico bancario en toda Europa. Lo mismo con los acuerdos de la Playa de Deauville entre Merkel y Sarkozy, que dispararon todas las alarmas de los inversores. La segunda posibilidad de destrucción podría venir, paradójicamente, de un intento de reforma fallido. Acorralados por una crisis, los líderes podrían tomar decisiones que salvaran temporalmente la moneda, pero la destruyeran a medio o largo plazo. Ese fue el caso de la URSS: el anquilosamiento de su economía creó las condiciones para el colapso, pero fue el intento de reformarla la que trajo su desintegración. Algo parecido podría ocurrirle a la eurozona, dice Zielonka, que no sobreviviera a las reformas introducidas en estos últimos años. ¿Cómo o por qué ocurriría esto? Muy sencillo, dice Zielonka: imaginemos que la salida que hemos adoptado para salir de la crisis, basada en la imposición simultánea de una misma receta de disciplina fiscal a todos los estados, agravara las tensiones entre estados. Esto es, en el fondo, bastante factible y ya lo estamos viendo: en ausencia de mecanismos de crecimiento, la austeridad no es sostenible y genera rechazo político y ciudadano. La tercera vía hacia la desintegración vendría vía la incapacidad de introducir reformas. Si por razones políticas, los Estados vieran que no pueden introducir reformas, prefiriendo ignorar las normas en vez de reformarlas, o actuar por fuera de los tratados, entonces la UE entraría en una senda de declive y languidecimiento. Formalmente, la UE seguiría ahí, pero dejaría de ser el centro político y de la política. Le pasaría algo parecido a lo que a otras muchas instituciones, que aunque hace tiempo hayan dejado de cumplir sus funciones, resulta más costoso deshacerlas que simplemente ignorarlas. Estos son los tres escenarios que plantea Zielonka en su libro. El autor se decanta por algo parecido al tercero: que la UE será más débil y no más fuerte como consecuencia de esta crisis pues no encontrará las energías internas suficientes para completar su diseño político e institucional. Abro el espacio para el debate entre los lectores. http://blogs.elpais.com/cafe-steiner/2014/06/como-seria-la-desintegracion-de-la-ue.html

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ft. com World Europe June 23, 2014 2:30 pm Herman Van Rompuy urges EU to do less By Peter Spiegel in Brussels

©AFP The EU should limit its ambitions over the next five years and not take on policy issues that can better be handled by individual member states, the chair of this week’s high- stakes EU summit has written in a draft blueprint to be sent to national capitals. The four-page “strategic agenda”, written by Herman Van Rompuy, the European Council president, warns that “public disenchantment” with Brussels has spread and urges the EU’s next leaders to be more focused. More ON THIS STORY// Cameron prepares to force Juncker vote/ Q&A The Juncker fight and why it matters/ Global Insight Juncker revolution/ Renzi leads push for less austerity/ Merkel urged to back down on Juncker IN EUROPE// Poland’s political elite bitten by bugs/ Bulgarians clash over Russian role in bank rescue/ Push to secure EU’s remaining top jobs/ Ukraine rebel leader agrees ceasefire “The union should only act when together we can achieve more than individual countries,” according to the memo, obtained by the Financial Times. “It should show self-restraint in exercising its competences when member states can better achieve the same objectives.” Mr Van Rompuy is hoping to agree policy guidance for the new European Commission at the same EU summit on Friday where Jean-Claude Juncker, the former Luxembourg prime minister, is expected to be nominated to head the EU’s executive branch. Many leaders who have raised questions about Mr Juncker’s selection, including Britain’s David Cameron and the Netherlands’ Mark Rutte, have argued that firm policy guidance is needed to ensure the EU changes tack after European Parliament elections saw anti-EU parties achieve unprecedented gains. Although Mr Van Rompuy’s “strategic agenda” provides guidance to “shape change”, its policy recommendations are largely the same as the EU has pursued in the past, including further liberalising the EU’s internal market; creating a new “energy union” to reduce reliance on foreign gas and oil imports; and better migration management. 159

Still, Mr Van Rompuy, who will discuss the draft with Mr Cameron at a meeting in London today, emphasises several points the British prime minister has been urging. Completing a trade deal with the US, energy independence and migration limits have all been on Mr Cameron’s list of priorities for the future EU leadership and are included in the Van Rompuy blueprint. It also argues that in further integration of the eurozone, “the integrity of the single market and openness towards non-euro countries should be preserved” – something London has been insisting on. Mr Van Rompuy also appears to be seeking to meet demands by centre-left EU leaders, particularly Italy’s Matteo Renzi and France’s François Hollande, to ease austerity demands in the EU’s recently-adopted budget rules. The draft mentions the rules’ “built-in flexibility” and the need to take “bold steps” on investments. Both Paris and Rome have suggested the rules provide leeway for more investment spending to spur economic growth, and in the document Mr Van Rompuy cites “overdue investment needs in transport, energy and telecom infrastructure” as priorities. It calls for “the right mix of private and public funding” to help improve the EU’s infrastructure, as well as developing “new financial capacities” to address investment needs. Mr Van Rompuy also touches on the delicate issue of migration, which helped spark anti-EU sentiment in Britain and France and has become an issue in several EU countries where so-called “social dumping” – lower-paid workers migrating into high- paid countries – has risen on the agenda, including Germany. The blueprint calls on the EU’s new leaders to prevent “fraud and abuses” of the EU’s requirement of free movement within the bloc, saying it undermines trust between countries and contributes to perceptions of so-called benefit tourism. It also calls for the EU to “better manage migration in all its aspects”, including “strengthened management” of the EU’s external borders. http://www.ft.com/intl/cms/s/0/65b9f7f6-fad5-11e3-8993- 00144feab7de.html#axzz35TR3FW4t

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Daily Morning Newsbriefing June 23, 2014 An emerging consensus for more fiscal flexibility The austerity days are well and truly over, at least in some parts of the eurozone. After Italy, Spain has become the latest country to cut taxes, and everybody is beginning to question the application of the current rules. At their meeting over the weekend, Socialist leaders demanded an EU-level agreement to interpret the existing fiscal pacts more flexibility. Suddeutsche Zeitung writes this morning that Angela Merkel will support a more lenient interpretation of the fiscal rules, but no formal changes in the rules. The rules themselves seem to be the red line in the negotiations, but the consensus is now that the existing rules offer enough flexibility. For example, the Commission is already entitled to give a country more time for deficit reduction if the country undertakes reforms to improve competitiveness or fiscal reforms. Reuters reports from the Ecofin that the European Commission will indeed review fiscal rules at the end of this year but only with a view to making them simpler. The article said the review will not bring changes to the formal framework, but might have an effect on the way the rules are interpreted and applied. The debate occurs against the backdrop of the IMF’s recent recommendation to reduce the rules to a single objective – debt sustainability – and a single operational target – the structural deficit (though that won’t happen). The most notable policy shift so far came from Spain where the government advanced some details of its much-awaited tax cuts. Cristóbal Montoro will present additional details today, and the package is due to be adopted on Friday. El Diario writes that the tax rates will be cut, and the system will be simplified. There are currently seven brackets, the highest one starting at €300,000 taxable income at a marginal rate of 52%. The number of tax bands will be cut to five, with the highest one starting at €60,000 at a rate of 45%. The tax-exempt minimum will be raised to €12,450. The list of tax credits will be expanded to support families with young children, the disabled and large families. In addition, the corporate tax rate will be lowered from 30% to 25%. Tax rates will drop in two stages, in 2015 and 2016. The paper comments it appears the recommendations of a “wise men” panel on tax reform have by and large been ignored, particularly on tax deductions. Olli Rehn said in Brussels that the European Commission had not been consulted “intensively” in the preparation of the tax reform and so will be analysing it to see whether it is compatible with the country-specific recommendations which were approved by the Ecofin on Friday, reports Vozpópuli. Commission recommendations for Spain include reducing income tax credits and shifting the tax burden from income tax to indirect taxes such as consumption, real estate or environmental taxes. 161

From Italy, former PM Massimo D’Alema is quoted by Frankfurter Allgemeine as saying that Matteo Renzi no longer needed to worry about the outgoing Commission. The government can promise to balance the budget, and then do whatever it likes. The paper names D’Alema as a possible Italian commissioner. In his FT column, Wolfgang Munchau says the loosening of the fiscal rules – much more so than the debate over Jean-Claude Juncker – constitutes the biggest development in the EU this year. He sets out what could be achieved – no change in the rules, but the possibility of accounting changes to separate out investments from general expenditure, special recognition of reforms. He see no majority for a formal change in the fiscal compact, but writes that Italy will – and should – ignore it in any case, especially the 20-year debt rule. Italy and other member states should prioritise debt sustainability, starting with the recognition that given present growth and inflation rates, even this less ambitious target is not ascertained now. The degree of pro-cyclicality of European fiscal policy is breath-taking. When spreads were high, everybody cut back. Now that spreads are lower, governments are cutting taxes. The right policy would have been to inflict less austerity during the Great Recession, and to start tightening fiscal policies as we come out of recession. Austerity has actually led to a deterioration of fiscal balances, while the current policies will ensure that fiscal balance will continue to deteriorate even as GDP growth resumes. This is not sustainable. We also do not think that this is an environment in which governments will enact structural reforms. On Juncker At their meeting, the Socialist leaders also endorsed Jean-Claude Juncker as expected – thus paving the way for a majority vote in the European Council. Paul Taylor has a good analysis on Reuters, in which he gathers Brussels views of the dead-end that David Cameron has manoeuvred himself into. Taylor invokes the image of a slow- moving train wreck – as there can be no happy ending to this confrontation. This article in the FT describes how Cameron misinterpreted the signals her received from Angela Merkel. In Germany, the SPD has now conceded that the CDU can nominate the German commissioner, while Martin Schulz will become EP president for another four years. The newly emerging Grand Coalition in Brussels is similar to that in Berlin. The EPP gets the big job, but the Socialists are influencing important policy shifts. Britain’s media only woke up to the reality of a Juncker Commission this weekend. But we should not forget that the problem is not just David Cameron’s (albeit clumsy) diplomacy. The Labour Party rejected Juncker, as did Nick Clegg. Virtually every UK commentator and leader writer did. What struck us was a widely expressed expectation that Angela Merkel would side with the UK. There are many ex-politicians in Germany who thought that Angela Merkel was on their side. It is astonishing that after her nine years in office, people still think the chancellor has innate loyalties. The return of old-style industrial policy in France The French government sealed a last minute deal on Sunday for the French state to become the main shareholder in Alstom to guarantee the "efficiency, solidity and sustainability" of the agreed alliance between Alstom and General Electric. Economy minister Arnaud Montebourg succeeded to secure an option to buy 20% of Alstom from

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Bouygues at an unspecified discount, provided the market value is at least €35 per share. If by then the state has not bought 20%, either from Bouygues or on the market, it has the right to purchase up to 15% at a similar discount whatever the market price. Alstom shares closed at €28.00 on Friday, Reuters reports. In Les Echos, David Barroux said this partial nationalisation was not necessary for the deal with GE, as Montebourg already exerted a heavy influence on the negotiations. The only reason for this extra expense of €2bn is political, to hammer down the message that if the state wants to, it 'can do'. Barroux warns that this way of political interference will certainly have a knock- on effect on other international companies who seek to invest in France. Cecile Cornudet remarks that Montebourg and Segolene Royal, who announced a state share in Ecomouv to control eco-tax collection, demonstrate that the government can influence the course of action. The problem is that their message runs somewhat contrary to the government's message for the last two years, that France should reduce its debts. Greek pension funds require €10bn by 2020 The Greek social security system is a ticking time bomb, writes Kathimerini. The cuts in public financing of the funds combined with the drop in the number of employed people and the major increase in pensioners have led to a social security time bomb. It is estimated that the pension system will require €10bn over the coming years until 2020. Market Scepticism on TLTRO The Wall Street Journal Economics Blog reports that eurozone banks are this week due to repay €12.6bn in LTRO lending this week, after repayments of €3.7bn last week. These early repayments may affect the take-up rate for the new TLTROs. The article reports that some analysts believe that the safeguards against misuse of the money for the purchase of government bonds could easily be circumvented. The argument is that the spread between market rates and the 0.25% of the VLTRO is so low that the threat to force banks to repay their TLTRO money early is not very powerful, and not likely to stop the banks from the sovereign bond carry trade. A Reuters poll last week also underlined general market scepticism about the impact of the TLTRO. Schieritz on housing Mark Schieritz praises Germany’s repressed housing market as providing financial stability. He says LTVs are typically 20-40%, with interest rates fixed for 10, sometimes 30 years, and no possibility of refinancing. This explains why Germany does not experience a house price boom – except in some urban areas. Germany experienced no house price booms in its post-war history, except after unification. He writes that this structural feature of the mortgage finance markets has implications for monetary policy. If the majority of the population rents their houses, a cut in rates will not lower mortgage costs, nor will it make more money available for consumption. Eurozone Financial Data 10y spreads

Previous This Yesterday day Morning France 0.345 0.346 0.349 163

Italy 1.479 1.509 1.511 Spain 1.399 1.387 1.409 Portugal 2.198 2.202 2.221 Greece 4.568 4.678 4.71 Ireland 1.109 1.119 1.151 Belgium 0.468 0.466 0.479 Bund Yield 1.323 1.346 1.344 exchange rates This Previous morning Dollar 1.358 1.3604

Yen 138.590 138.67

Pound 0.797 0.7986

Swiss Franc 1.217 1.2173

ZC Inflation Swaps previous last close

1 yr 0.77 0.75

2 yr 0.86 0.84

5 yr 1.23 1.23

10 yr 1.65 1.66

Eonia

20-Jun-14 0.03

19-Jun-14 0.01

18-Jun-14 0.02

17-Jun-14 0.03

OIS yield curve 1W 0.070 15M 0.047 2W 0.052 18M 0.051 3W 0.051 21M 0.083 1M 0.008 2Y 0.072 2M 0.075 3Y 0.161 3M 0.062 4Y 0.272 4M 0.063 5Y 0.408 5M 0.061 6Y 0.581 6M 0.058 7Y 0.758 7M 0.042 8Y 0.929 8M 0.041 9Y 1.086

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9M 0.055 10Y 1.227 10M 0.060 15Y 1.735 11M 0.072 20Y 1.963 1Y 0.053 30Y 2.061

Euribor-OIS Spread previous last close

1 Week -5.143 -4.143

1 Month 4.000 7.7

3 Months 9.543 11.443

1 Year 36.971 38.871

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-06- 23.html?cHash=55577309396e8eece901f10fec8af75f June 22, 2014 7:46 pm Merkel versus Renzi for the future of the eurozone

By Wolfgang Münchau Rome’s demand for a fundamental rethink of the fiscal rules sets the scene for a political tussle Behind the big battle for the presidency of the European Commission lies an important debate that has not yet caught much attention – at least not outside Italy and Germany. It is Rome’s demand for a fundamental rethink of the fiscal rules in the eurozone. The immovable object of Angela Merkel’s fiscal orthodoxy is about to meet the irresistible force of Matteo Renzi’s restlessness. Sit back and enjoy. On July 1 the Italian prime minister will take over the six-month presidency of the EU. He has big plans. The bloc’s rotating presidency is no longer what it used to be since the European Council, composed of heads of government, appointed its own permanent president five years ago. But this detail has not deterred Mr Renzi from launching what is essentially a unilateral agenda. The German chancellor has already said Nein – but the tone is still civilised. More ON THIS STORY// Leftwing leaders back Juncker for top Brussels post/ Renzi leads push for less austerity/ Pressure on Renzi to reveal EU choice ON THIS TOPIC// Survey suggests slowing eurozone recovery/ Markets Insight Brace for bond market bumps ahead/ Wolfgang Münchau Europe’s debt horrors/ Carney boosts ECB fight against deflation

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WOLFGANG MÜNCHAU// Europe’s drifters wait/ Italian rescue/ Change inflation tactics/ Draghi’s missed chance on inflation Mr Renzi proposes three specific changes. The first is a weakening of the official fiscal rules. The second is a change to the fiscal compact – a multilateral treaty signed by all EU members except the UK, Croatia and the Czech Republic. The offending item is a binding debt-reduction rule. The third demand is a jointly funded investment programme. He will almost certainly not see his first wish fulfilled. But he may still get what he needs, an agreement by the next commission to interpret the fiscal rules more flexibly. As long as Jean-Claude Juncker, the former prime minister of Luxembourg, promises a fiscal blind eye, he will be able to count on Mr Renzi’s support in his bid for the commission presidency job. Mr Renzi may be the swing vote. This puts the Italian prime minister in a good position to extract concessions from any future commission president. Assuming Mr Juncker gets the job, what could he do to help Italy? For a start, he could give countries more time for deficit reduction. He could introduce a subversive accounting change by subtracting investment spending from deficit calculations. Mr Renzi badly needs concessions such as these. He would otherwise face the dreaded “excessive deficit procedure”, which the commission slaps on countries that fail to meet their fiscal targets. With his eccentric 2014 budget – consisting of tax cuts funded by uncertain revenue measures – Mr Renzi has taken a big fiscal risk. He clearly wants the commission off his lawn. On the fiscal compact, however, I see less leeway. There was never much of an economic rationale for a rule that restricts the amount of debt to an arbitrary 60 per cent of gross domestic product. The sole purpose of the fiscal compact was to give the German public peace of mind during the euro crisis. It contains the message – or rather the lie – that the eurozone member states are happily committed to debt reduction. But there is no way the Italians will reduce their country’s debt-to-GDP ratio by 75 percentage points in 20 years as the debt rule demands. Nor should they. They should instead focus on the broader concept of debt sustainability, the one goal that really matters. Even this would be unattainable with present growth and inflation rates. To generate more growth, Italy and everyone else in the eurozone need more investment. On this point, Mr Renzi might get lucky. Ms Merkel may be open to an EU- wide investment programme. Her Social Democrat coalition partner is demanding one. Sigmar Gabriel, SPD chairman and economics minister, surprised everyone by saying that countries should get more time for deficit reduction if they commit to reforms. He is also in favour of excluding investments from the deficit calculations. German conservative economic commentators had a collective panic attack. Mr Gabriel was accused of favouring a change in the rules – which technically is not true – and of undermining Ms Merkel’s negotiating position. The latter is both true and, I presume, intended. The impact of an EU-wide investment programme will depend almost entirely on its size and the speed of its introduction, more than on what the money is spent on. Austerity has led to a dramatic fall in public and private investment everywhere in the eurozone. Germany needs to invest just as Italy does – in infrastructure, education, energy networks, and research and development.

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With interest rates close to zero, such a programme would be essentially self-financing. It could also help raise potential growth if the investments were to lead to an increase in productive capacity. It could be funded through five or 10-year bonds issued by the European Investment Bank. The European Central Bank could then buy most of these bonds as part of a future programme of asset purchases, which I expect to happen later this year. The history of the eurozone suggests that change takes time and always falls short. But this is the kind of debate the eurozone needs. Its outcome will help us understand whether Italy and other indebted member states can coexist in a monetary union with Germany. I still have my doubts. But Mr Renzi’s determination constitutes an important development nevertheless. http://www.ft.com/intl/cms/s/0/342ef1a6-f7b9-11e3-b2cf- 00144feabdc0.html#axzz35TR3FW4t online.wsj.com Juncker's Selection Will Be Defining Moment for EU EU Spats Often Get Blown Out of Proportion. But Not This One By Simon Nixon Updated June 22, 2014 7:58 p.m. ET

Jean-Claude Junker speaks during an election campaign event for the European election in May. If, as seems likely, he is selected this week to head the European Commission,

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the European Union's governing apparatus will be fundamentally changed. Associated Press European political rows often get blown out of proportion. What may seem momentous at the time can turn out to matter little. For all the bluster, a deal is reached, compromise agreed, tempers cool—and the business of the European Union goes on. The uproar over Jean-Claude Juncker's candidacy for the presidency of the European Commission, which has pitted the U.K. against Germany and many other member states, isn't one of Europe's passing political storms. If the former prime minister of Luxembourg is appointed this week at a summit of European leaders—as now seems all but inevitable—then nothing in the EU is likely to be the same again. It will be a defining moment. Related// Calls for QE Pose Headache for ECB The most obvious consequence is for the U.K.'s relationship with the EU: This may now have to change radically to avoid the country voting to quit the EU in a referendum due to be held by 2017. Only weeks ago, this was looking less likely. For all Prime Minister David Cameron's diplomatic missteps in Europe, he appeared to be winning the argument on the need to reform the EU to make its markets more competitive, to cut red tape and to clip the power of Brussels by returning powers to member states. Importantly, his strategy seemed to be working at home, too: Since the start of the year, polls had showed a clear shift back in favor of EU membership. To many Europeans, it seems extraordinary that an argument over Mr. Juncker could put all this at risk. After all, Mr. Juncker is hardly the boogeyman that parts of the U.K. media have made him out to be. He's an experienced politician, a good negotiator, not confrontational. Coming from the EU's smallest state his instincts may be integrationist, but he comes from the same part of the political spectrum as Mr. Cameron and has been notably sympathetic to the need to address British concerns to keep the U.K. in the EU. Mr. Juncker's supporters argue that Mr. Cameron could achieve at least 90% of his EU reform priorities with the Luxembourger as commission president, aided by the prospect of a top commission economic portfolio for the U.K. as a mark of goodwill. But those urging Mr. Cameron to cut a deal with Mr. Juncker are underestimating the extent to which this standoff has become an issue of principle—not just for Mr. Cameron but for much of the U.K. political class, including many committed pro- Europeans. British support for EU membership has always been based on the understanding that the EU is an association of nation states rather than a federation. That is why Mr. Cameron's commitment to change EU treaties to abolish the principle of "ever-closer union," at least as it applies to the U.K., is central to his referendum strategy. The U.K. has always understood that countries using the single currency would need to pursue deeper integration, but the price of its support for integration at the eurozone level has always been respect for national sovereignty at the EU level. Mr. Juncker's appointment threatens to blow apart this understanding. To British eyes, the process by which he emerged as the likely appointee—he was the lead candidate, or Spitzenkandidat, of the European People's Party, the largest party group in the European Parliament—is a breach of treaties that say it is the job of the European Council to nominate a commission president. Never before has the council overridden a member 168

state on this crucial issue. Conceding this principle would set an irreversible precedent, boosting the power of the Brussels-based institutions at the expense of nation states and allowing future commission presidents to claim a bogus legitimacy. Far from abolishing the principle of "ever-closer union," the EU would have hard-wired it into its key institution. Nor should one underestimate the psychological impact of a defeat over Mr. Juncker. British officials are incredulous at the position they now find themselves in. They know that their concerns are widely shared; they are frustrated at the gap between what some EU leaders say in public and private, and believe they were given assurances by Germany's Chancellor Angela Merkel that Mr. Juncker would be dumped; worse, some believe she has deliberately undermined their efforts to organize a blocking minority. This standoff now risks damaging Anglo-German relations. Some British officials feel they are being dealt a brutal lesson in German power and are upset that their assiduous courting of Ms. Merkel, who was feted on a lavish quasi-state visit to the U.K. only months ago, should have yielded so little. Just as the Bundesbank's refusal to come to the U.K.'s aid when sterling was under pressure at the height of the 1992 Exchange Rate Mechanism crisis hardened the resolve of a previous generation of U.K. officials and politicians never to join the euro, so Germany's insistence on putting domestic political considerations above what these British officials see as the wider European interest could harden attitudes among the current generation toward EU membership. For their part, German officials believe London is overestimating Berlin's room for maneuver. They say they are powerless to stop Mr. Juncker since the European Parliament has said it would refuse to ratify anyone else, threatening a potentially destabilizing intuitional power struggle. Ms. Merkel is also under intense pressure to accept the Spitzenkandidat process, both domestically as well as from smaller EU states which see a politicized commission as the best way to counterbalance the power of larger states in the council. Some in Berlin fear that Mr. Cameron's opposition to Mr. Juncker is fueling anti-British sentiment, reducing the political space for concessions to keep the U.K. in the EU. But Mr. Cameron isn't backing down; if necessary he will force a vote at the summit, according to those familiar with his thinking. He believes he is acting in Europe's best interests, not least the interests of Germany, which may have most to lose with a politicized commission shorn of the free-market influence of the U.K.—because that is where the logic of Mr. Cameron's stand is leading, even if neither side dares to admit it. Write to Simon Nixon at [email protected] http://online.wsj.com/articles/junckers-selection-will-be-defining-moment-for-eu- 1403467081

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Daily Morning Newsbriefing June 20, 2014 Renzi will get more flexibility, but no change of fiscal rules The most informed analysis on the debate about Matteo Renzi’s proposal to loosen the fiscal rules comes from Federico Fubini who writes in La Repubblica this morning that most of what Renzi is proposing for his EU presidency is unlikely to become reality. Concretely, Renzi is proposing three things. The first is a formal loosening of the existing fiscal rules. Herman van Rompuy told him that the European Council would have to vote in favour of such a change, and that this was not likely to happen. Renzi is thus settling for a more flexible interpretation of the existing rules, which is a matter for the Commission. In view of Italy’s likely budget overshoot for 2014, the outgoing Commission is currently considering to launch an excessive deficit procedure against Italy. The second proposal is a formal change to the fiscal compact. The article said that Angela Merkel will not accept such a change, given the outraged political reaction to Renzi’s proposals in Germany. The third proposal is an EU-level investment drive, something the Berlin Grand Coalition is considering as possible, but only as a quid-pro-quo for economic reforms. So even this proposal should not be taken as given. In its Article IV Consultations the IMF proposed a simplification of the fiscal rules – reducing them to a single target – debt sustainability – and one operational lever – the structural balance. The credibility of the rules would also be enhanced by much stronger enforcement mechanisms. Werner Musler writes in Frankfurter Allgemeine that Renzi will probably not prevail on a formal change of the rules, but this was not needed anyway. The rules are very flexible as they are. On Renzi’s proposal to subtract investments from the deficit calculations, Musler writes that this would require an initiative from the European Commission. Renzi has a lever at his disposal - to link his approval of Jean-Claude Juncker to a commitment to his own agenda (which we are sure Juncker will give him). After having expressed his utter outrage at Renzi’s proposals in a small commentary earlier this week, Holger Steltzner, the economics editor of FAZ, hyperventilates in a large one. He calls on Merkel to align herself with the UK – as France and Italy, with the help of German Social Democrats, are ganging up on Germany. Luis de Guindos took the hawkish side in the debate on European fiscal rules, writes Europa Press. In this he joined German finance minister Wolfgang Schäuble and Commissioner Olli Rehn, who insisted on sticking to the existing rules. The Italian and

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French finance ministers Pier Carlo Padoan and Michel Sapin insisted on prioritizing growth and employment. Regling says no margins for rate cuts Not much leaked out of the Eurogroup meeting, while a tweet was noticing that the meeting stopped coincidentally when the football game Colombia against the Ivory Coast began. Jeroen Dijsselbloem told the press afterwards that Greece’s new finance minister Gikas Hardouvelis had assured his counterparts that “the first prior actions will have been completed by the end of the month" according to Kathimerini. On debt relief for Greece Klaus Regling said there is no margin for reducing the rates on EFSF (and ESM?) loans, as “at the moment we are charging the least possible and if we reduce our rates further then someone will need to compensate us.” That someone could be the eurozone member states, which does not appear likely, he said. With respect to Portugal, Regling said the Constitutional court "has not made life easier to the Portuguese Government" and the court has held a "pretty extreme" position when compared with other European courts, Diario Economico reports. Regling also noted that the rates Portugal got on its bonds were cheaper than the IMF loan. He said the absence of a negative reaction in the markets after the court decision is due to the certainty that the executive will "provide compensation measures again." IMF downbeat on SRM and economic outlook The leak of the IMF’s Article IV Consultations focused on QE. What we find more interesting is the IMF’s critical assessment of the Single Resolution Mechanism and the broad economic outlook. On the SRM, the document says: “The current planned backstop may prove insufficient to break decisively bank- sovereign links. While the proposal for ESM direct recapitalization is a step in the right direction, as currently envisaged, the thresholds for such support are too high. Overall, centralized resolution resources may not be sufficient to handle stress in large banks.” On the economy, the IMF says that the recovery of private investment was weaker than after previous recessions; that balance sheets remained impaired; that inflation is worryingly low and that real interest rates are too high; and that unemployment was becoming structural, and hampered economic growth potential. 30 years of worker training fraud in Spain In the wake of a recent scandals involving subsidised training courses for workers and the unemployes in madrid and Andalusia, El País (English edition) has a story recounting the 30-year history of fraud in training courses. This harkens back to 1984 when employers and unions agreed to set up a system of worker training at a time when unemployment was at historical highs now surpassed due to the current recession. Unlike in Germany, where worker training happens on the job and is by and large not ublicly subsidised, in Spain employers and the public emplotment services alike outsource training to private firms which receive public subsidies. There is a cottage industry of subsidy capture by means of phony training firms, aided by lax supervision by the agencies responsibe for the subsidies. A parallel is made with the French system as it was before a high-profile scandal in 2007 motivated the French Parliament to set up a more transparent system of financing for training courses. 171

The European conventional wisdom of “active employment policies” attributes high unemployment to skills mismatches and proposes to train the unemployed to make them “work ready”. The problem is that, unlike with on-the-job training, there is no guarantee that there will be jobs waiting for the people who complete a training program. In fact, once a cottage industry of subsidy capture is set up around unemployed training, there is a perverse incentive to offer training not conducive to a job to maintain demand for worker training. Policy should shift from managing the unemployed to creating jobs and training people for them once hired. China gives Greece investment boost Greek and Chinese officials on Thursday signed more than a dozen bilateral investment and trade agreements, a total of 19 deals worth an estimated $6.5bn, according to Kathimerini. Two thirds of the planned investments relate to the shipping sector, the remaining is in the energy and real estate sector, writes Macropolis. China's premier also signalled interest in Greek bonds. Greece’s return to international bond markets in April showed that “the Greek people have the wisdom and ability to emerge from the crisis,” Li Keqiang told a joint press conference with Antonis Samaras. When the Greek government next issues bonds, he said, “China will continue to be a long-term, responsible investor.” Samaras told reporters that “Greece can become China’s gateway to Europe, and the start of a European trade corridor between Europe and the Far East.” The exchange behind closed doors was more than cordial according to sources, with Li reportedly describing Greece as “China’s most stable and faithful friend in Europe.” The rebound of investments is key for Greece to achieve the GDP growth forecast of 0.6% in 2014. Greece and the troika expect gross fixed capital formation to grow by 5.3% in 2014 and 11.7% in 2015 after it plummeted by almost 60% since 2008.

Crisis worsened Income inequality New OECD data shows that lower-income households across the OECD were hit harder by the financial crisis — the poor either lost more during the crisis or benefited less from the recovery than did the higher-income households. The distribution of pre-tax and transfer income remains significantly more unequal than it was before the crisis. 172

Taxes and social transfers cushioned much of this increase of market income inequality, with relatively small changes in inequality of household disposable income. But, given the weakness of the recovery in most countries, the income of the poorest 10% of the population has continued to decline or to increase less than that of the richest 10%. A long-term pattern documented in previous OECD reports further intensified during the crisis-years: youth have replaced the elderly as the group experiencing the greater risk of income poverty.

http://www.oecd.org/els/soc/OECD2014-Income-Inequality-Update.pdf Schauble professes concern about house price inflation We completely agree with Guntram Wolff’s comment as reported by the Wall Street Journal: "Saying that an economy with 1% credit growth is overheating is just insane." Wolfgang Schauble, however, keeps banging on about the “dangerous” increases in German properties prices, as reported by Reuters, adding that liquidity in the system was too high, and that interest rates were too low. “Just insane” is about the most polite thing you can say about this. German house prices are still massively undervalued by eurozone standards. What we are seeing here is a long overdue adjustment, which is what you expect to happen in a monetary union. Since the increase in prices is not driven by credit, there is absolutely nothing to worry about from a financial stability point of view. What the Argentina ruling means for the eurozone The formidable Anna Gelpern has a good commentary on the Peterson Institute website. She explains that the US Supreme Court has passed two rules. The first is not to override the previous ruling by the Second Circuit in New York, which ordered Argentina to pay creditors holding defaulted bonds in full. The second part is to allow creditors to subpoena banks to provide information about Argentina’s assets around the world irrespective of whether these assets are immune from seizure or not. She makes two points of interest to us. The first is that the ruling has produced a huge mess. It could leave a country as “a financial pariah, unable to do basic financial business outside its borders.” At stake is not just what happens in Argentina, but how this impacts the global financial system. On the implications for Europe, she writes:

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“… courts in the United Kingdom, Belgium, and elsewhere are in a bind. They are not bound by the US decisions, but cannot ignore the highest court in the United States blessing a contract interpretation and a remedy that might conflict with their own jurisprudence, or, in the case of Belgium, with national legislation shielding the Euroclear system from the kinds of remedies issued by the New York courts. It will be interesting to see how they resolve the conflicts.” Bean-counting the cost of the EU presidency Greece breaks a new record: its six-month EU presidency, set to end on June 30, will be the least costly ever, Kathimerini reports. The total expenses are not expected to exceed €25m and are more likely to be between €18m-€20m, which is well below half of the €50m earmarked, according to their sources in the foreign ministry. Although the sum is relatively small, it will be a symbolic indication that the Greek state is capable of avoiding wasteful spending. It is significantly lower than the €65m spent by Cyprus in the second half of 2012. Foreign Ministry staff who have worked overtime did not receive additional pay, while the contribution of sponsors and the decision to stage the bulk of the events at state-owned venues, rather than renting out private spaces, helped rein in costs. We suspect that Matteo Renzi, who has big plans for the upcoming Italian EU presidency, will not think in those categories. Eurozone Financial Data 10y spreads

Previous This Yesterday day Morning France 0.368 0.345 0.346 Italy 1.479 1.500 1.490 Spain 1.383 1.399 1.405 Portugal 2.169 2.198 2.203 Greece 4.547 4.568 4.57 Ireland 1.098 1.109 1.093 Belgium 0.489 0.468 0.469 Bund Yield 1.377 1.323 1.333

exchange rates This Previous morning Dollar 1.364 1.3625

Yen 138.770 138.79

Pound 0.802 0.799

Swiss Franc 1.217 1.2165

ZC Inflation

174

Swaps previous last close

1 yr 0.77 0.77

2 yr 0.86 0.86

5 yr 1.23 1.23

10 yr 1.65 1.65

Eonia

19-Jun-14 0.01

18-Jun-14 0.02

17-Jun-14 0.03

16-Jun-14 0.03

OIS yield curve 1W 0.025 15M 0.048 2W 0.025 18M 0.051 3W 0.030 21M 0.077 1M 0.040 2Y 0.066 2M 0.050 3Y 0.139 3M 0.073 4Y 0.248 4M 0.055 5Y 0.397 5M 0.055 6Y 0.567 6M 0.055 7Y 0.743 7M 0.055 8Y 0.918 8M 0.050 9Y 1.071 9M 0.065 10Y 1.212 10M 0.065 15Y 1.721 11M 0.066 20Y 1.949 1Y 0.044 30Y 2.046

Euribor-OIS Spread previous last close

1 Week -2.571 -3.271

1 Month 3.214 4.514

3 Months 10.586 12.786

1 Year 40.014 39.914

Source: Reuters

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Renzi will get more flexibility, but no change of fiscal rules • Herman van Rompuy tells Matteo Renzi that a formal change of fiscal rules would require a decision in the European Council, and that this is not going to happen; • Renzi is open to a smaller version of the proposal – more flexibility in the way the rules are applied – which is the prerogative of the European Commission (hence Renzi’s insistence that Juncker must pre-commit to his agenda as a quid-pro-quo for supporting Juncker for the Commission presidency); • Italy still insists on the other two goals: a formal change in the Fiscal Compact, and an EU-wide investment initiative; • Federico Fubini writes that Germany will not budge on the compact, but could be persuaded to support an investment programme – but the conditions will be onerous; • the IMF says the eurozone should simplify its fiscal rules – with debt sustainability as the single target and the structural deficit as the single instrument; • Werner Musler writes Renzi will not prevail with his attempt to change the rules, but this is not needed anyway since the rules are very loose these days; • Holger Steltzner says Angela Merkel should side with David Cameron against Renzi and Francois Hollande; • Luis de Guindos sides with Schäuble and Rehn against Padoan and Sapin in the debate on fiscal rules;

Further News • Gikas Hardouvelis assured his colleagues at the Eurogroup meeting that the first prior actions will have been completed by the end of the month; • On debt relief Regling said there is no margins to cut interest rates further; • and says that Portugal's constitutional court is "pretty extreme" compared to other EU courts; • The IMF writes in its Article IV consultations that the backstop in the single resolution mechanism would be insufficient to break the link between banks and sovereigns; • document is also downbeat on economic recovery – which it says is hampered by weak investment, damaged balance sheets, low inflation and high real interest rates, and hysteresis; • El País has an article describing the 30-year-old system of worker training which has become a cottage industry of fraudulent subsidy capture; • Greece and China signed off 19 bilateral investment and trade deals and PM Li also signalled interest in the next bond issuance as part of long term investment strategy; • New OECD data shows that lower-income households were hit harder by the crisis or benefited less from the recovery than higher-income households; • Wolfgang Schauble says house price inflation is dangerous; • Anna Gelpern writes that the Supreme Court’s ruling on Argentina will have profound implications for the global financial system, and for Europe in particular; • Greece, meanwhile, is about to break symbolic record of going down into the books as the cheapest EU presidency ever recorded; • Eurozone Financial Data

http://www.eurointelligence.com/professional/briefings/2014-06- 20.html?cHash=f0287d3007c52d94d531e5718b9fc171

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ECONOMÍA/MACRO Alemania, España y la CE rechazan flexibilizar el Pacto de Estabilidad Italia y Francia reclaman dar prioridad al crecimiento y el empleo sobre la consolidación fiscal LUXEMBURGO, 19 Jun. (EUROPA PRESS) - Alemania, España y la Comisión Europea han rechazado este jueves reformar el Pacto de Estabilidad y Crecimiento para relajar la disciplina fiscal y consolidar la recuperación económica con el argumento de que las reglas actuales ya prevén suficiente flexibilidad. Por su parte, Italia y Francia han reclamado que la UE dé prioridad al crecimiento y el empleo sobre la consolidación presupuestaria, aunque han aclarado que tampoco ellos quieren cambiar las reglas. "El Gobierno alemán opina unánimemente que las reglas que existen son suficientemente flexibles", ha dicho el ministro alemán de Finanzas, Wolfgang Schäuble, a su llegada a la reunión del Eurogrupo. "No hay que cambiar las reglas, hay que cumplirlas", ha defendido. "Propongo que cumplamos todos las reglas, lo que decidimos: política de finanzas sólidas y reformas estructurales. Entonces tendremos más éxito en la lucha por más inversión, crecimiento duradero y en contra del paro", ha indicado Schäuble. También el vicepresidente de la Comisión y responsable de Asuntos Económicos, Olli Rehn, ha sostenido que "es importante continuar con una consolidación coherente de las finanzas públicas". "En mi opinión, es importante respetar las reglas presupuestarias, que ya tienen un grado significativo de flexibilidad", ha apuntado Rehn, que deja su cargo el 1 de julio para convertirse en eurodiputado raso. Para el ministro de Economía, Luis de Guindos, es necesario continuar con el proceso de reducción del déficit público a un ritmo adecuado y también con las reformas económicas. "España es favorable a no modificar las reglas continuamente. Es fundamental tener reglas estables, predecibles y sensatas y yo creo que en este momento las tenemos", ha alegado Guindos. MOVILIZAR TODOS LOS INSTRUMENTOS PARA EL CRECIMIENTO En contraste, el ministro de Finanzas italiano, Pier Carlo Padoan, ha reclamado "poner sobre la mesa todos los instrumentos de los que Europa ya dispone para acelerar el crecimiento y el empleo". Padoan ha negado no obstante que su Gobierno esté pidiendo excluir las inversiones productivas del cómputo del déficit. "La prioridad es el crecimiento y el empleo porque durante muchos años la UE ha puesto sobre la mesa otras prioridades como la consolidación fiscal o la unión bancaria", ha dicho el ministro italiano. "Se han hecho muchos progresos en estos campos, pero faltan progresos sobre el tema crecimiento y empleo", ha insistido. "No pedimos un cambio de reglas, se trata de un problema de ritmo", ha afirmado por su parte el representante francés, Michel Sapin. "No se trata de cambiar las reglas: las reglas son las reglas. Hay que buscar el buen ritmo para cada uno de los países, en particular para los países con más dificultades, con el fin de que el retorno a una situación presupuestaria controlada, la disminución ordenada de la deuda y el déficit, se haga en condiciones no sólo compatibles sino que también generen crecimiento", ha solicitado. http://www.europapress.es/economia/macroeconomia-00338/noticia-economia-macro- alemania-espana-ce-rechazan-flexibilizar-pacto-estabilidad-20140619174608.html 177

Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments. 2014 Article IV Consultation with the Euro Area Concluding Statement of the IMF Mission 1. The euro area recovery is taking hold. Real activity has expanded for four consecutive quarters. An incipient revival in domestic demand is adding to the impetus from net exports. Financial market sentiment has improved dramatically, particularly after the recent ECB measures. Sovereign and corporate yields are now at historic lows in many countries, and lower funding costs have helped banks raise more capital. 2. Strong policy actions have boosted investor confidence and laid the foundations for recovery. At the national level, governments have made progress in repairing sovereign and bank balance sheets and pursuing structural reforms to restore competitiveness. At the area-wide level, policy makers have demonstrated collective commitment to the EMU, for example, through progress on building a banking union. And the ECB has taken a wide range of measures to support demand and address fragmentation. The ECB’s Comprehensive Balance Sheet Assessment to be completed later this year is encouraging recapitalization and helping boost confidence in the banking system. 3. But the recovery is neither robust nor sufficiently strong. • Activity and investment have yet to reach pre-crisis levels. The recovery of private investment has been weaker than in most previous recessions and financial crises. In the first quarter of 2014, growth was weaker than expected and unevenly distributed across countries. • Balance sheets are still impaired and debt levels elevated. Public debt levels remain high. Weakness in banks’ balance sheets inhibits the flow of credit and corporate and household debt overhangs impede demand. • Inflation is worryingly low, including in the core countries. By keeping real interest rates and real debt burdens elevated, very low inflation stifles demand and growth. It also makes difficult the adjustment in relative prices and real wages that must occur for sustainable growth to take hold.

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• Unemployment, especially among the youth, is unacceptably high. The average rate for the euro area is around 12 percent. Youth unemployment is even more elevated, averaging close to 25 percent. High unemployment erodes skills and human capital, inflicting permanent damage on the capacity of economies to grow. 4. Much higher growth is needed to bring down unemployment and debt. With the benign market environment, now is the time to implement reforms to increase growth. Policy efforts should focus on three areas: (1) demand support; (2) balance sheet repair and completion of the banking union; and (3) the advancement of structural reforms. Providing more demand support 5. The ECB’s recent actions signal its determination to address low, below-target inflation and fulfill its mandate. Collectively, the wide range of measures should lead to a substantial expansion of liquidity. The provision of targeted term funding for banks should encourage credit growth in stressed economies. 6. The ECB’s willingness to do more, if necessary, is reassuring. If inflation remains stubbornly low, the ECB should consider a large-scale asset purchase program, primarily of sovereign assets according to the ECB’s capital key. This would boost confidence, improve corporate and household balance sheets, and stimulate bank lending. Overall, it holds the potential to have a significant impact on demand and inflation. 7. After several years of consolidation, the overall fiscal stance for the euro area is close to neutral. This strikes the right balance between demand support and debt reduction. But large negative growth surprises should not trigger additional consolidation efforts. Mending balance sheets and completing the banking union 8. Progress on the ECB’s Comprehensive Assessment has been encouraging. Banks have already raised substantial capital in anticipation of the results of the Asset Quality Review (AQR) and associated stress tests. The ambitious timetable for recapitalization of banks should be feasible given markedly improved market conditions. The ECB should continue to urge banks to be proactive in raising capital. 9. There has been substantial progress towards a more complete banking union. The transition to a single supervisor—the Single Supervisory Mechanism (SSM)—will facilitate cross-border liquidity provision, thereby reducing fragmentation. Single Resolution Mechanism (SRM) decision-making procedures have been simplified. And, the timetable for mutualization of the Single Resolution Fund (SRF) has been shortened. 10. Work needs to continue to establish a common backstop to sever effectively sovereign-bank links. The current planned backstop may prove insufficient to break decisively bank-sovereign links. While the proposal for ESM direct recapitalization is a step in the right direction, as currently envisaged, the thresholds for such support are too high. Overall, centralized resolution resources may not be sufficient to handle stress in large banks. 11. Working out the corporate debt overhang would help spur investment. Many countries have taken steps to reform their insolvency regimes. These efforts need to continue, together with progress on harmonizing national insolvency frameworks. 179

Measures should also be taken to facilitate out-of-court settlements, reduce impediments to debt restructuring, and introduce guidance on resolution procedures in line with international best practices. Advancing structural reforms 12. More structural reforms will be necessary to revive investment, employment, and productivity, as well as to reduce imbalances. • To this end, national reforms to improve labor market functioning and increase competition in product and service sectors need to progress further. These would be helped by efforts at the euro area level to implement the Services Directive, negotiate free trade agreements, and further integrate energy markets to mitigate possible disruptions in global commodity markets due to geopolitical events. • Further policy efforts in both creditor and debtor economies are necessary to ensure that intra-euro area imbalances do not re-emerge as the recovery takes hold. In particular, higher infrastructure investment in creditor economies and further strides in improving competitiveness in debtor economies would be needed. 13. A comprehensive strategy to tackle youth unemployment requires measures to boost growth and remove country-specific structural impediments. Specifically, reducing the tax wedge could lower hiring costs. Bringing minimum wages more in line with average labor costs would avoid pricing the youth out of the labor market. And better-targeted work-related training programs would help align skills with job opportunities. 14. Capital market development should be encouraged to support investment and growth. Encouraging capital market financing alternatives—such as greater securitization for corporate funding—would help ensure lending to viable small firms and reduce the reliance on banks for credit. For instance, reducing regulatory capital charges for high-quality securitization structures would free up banks capital for further lending. 15. Over the medium term, ideas that simplify and strengthen the fiscal governance framework should be explored. • Successive reforms of the SGP have introduced many positive elements. However, the system has become excessively complicated with multiple objectives and targets. Compliance with fiscal targets has been poor, reflecting in part weak enforcement mechanisms. And there is a worry that the framework discourages public investment. • There are no easy solutions to these problems. Nevertheless, consideration should be given to a simpler framework with a single objective and an economically sound operational lever. For example, debt reduction could be the ultimate fiscal objective and the structural balance as the single operational target. The credibility of the rules would also be enhanced by much stronger enforcement mechanisms. • Boosting the ability of the center to fund public infrastructure projects—such as cross-border investments in transportation, communications, and energy

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networks—would help lay the foundations for sustained growth, while keeping countries within the bounds of the fiscal framework. 16. In sum, concerted policy efforts are needed to strengthen the recovery. Continued demand support is vital to address low inflation. The favorable market environment also provides a window of opportunity to make further progress on repairing balance sheets and advancing structural reforms. Together, these will create the conditions for higher growth, job creation, and a durable recovery. http://www.imf.org/external/np/ms/2014/061914.htm

Economía

El Ecofin pedirá a España rebajar las cotizaciones, subir el IVA y nueva reforma laboral ep@ABC_es Día 19/06/2014 - 13.10h Las recomendaciones amenazan con provocar un choque, ya que el Consejo de Ministros aprueba ese mismo viernes la reforma fiscal, en la que tiene previsto ignorar las medidas de la UE

afp El vicepresidente y responsable de Asuntos Económicos y Monetarios, Olli Rehn (i) conversa con el ministro español de Economía, Luis de Guindos Los ministros de Economía de la UE pedirán este viernes a España «nuevas medidas» para acabar con la segmentación en el mercado laboral -entre ellas la reducción del número de contratos y la aproximación de sus costes de despido- así como rebajar las cotizaciones sociales y compensar la pérdida de ingresos con subidas del IVA y de impuestos medioambientales con el objetivo de acelerar la creación de empleo. El Ecofin exige además a España concretar los ajustes que tiene previsto adoptar para cumplir los objetivos de reducción de déficit en 2015 (4,2%) y en 2016 (2,8%). Las recomendaciones del Ecofin -que ratificará sin cambios las propuestas que hizo la Comisión el 2 de junio, según el documento al que ha tenido acceso Europa Press- amenazan con provocar un choque entre España y la UE. 181

Precisamente, el Consejo de Ministros aprueba ese mismo viernes la reforma fiscal, en la que tiene previsto ignorar las medidas de la UE, ya que ha anunciado una rebaja del impuesto sobre la renta desde 2015 sin explicar cómo compensará la pérdida de ingresos, y ha descartado subir el IVA o reducir las cotizaciones. La ministra de Trabajo, Fátima Báñez, rechaza también otra reforma laboral. Las recomendaciones para España, así como las dirigidas al resto de Estados miembros, serán ratificadas no obstante por los jefes de Estado y de Gobierno en la cumbre del 26 y 27 de junio. Reforma tributaria, aprobada antes de fin de año En materia tributaria, el Ecofin pide en concreto a España que adopte antes de fin de año «una reforma fiscal completa, que simplifique el sistema impositivo y haga que contribuya en mayor medida al crecimiento y creación de empleo, así como a la preservación del medio ambiente y la estabilidad de la recaudación». «Para este fin debe: trasladar la tributación hacia impuestos que distorsionan menos, como los que gravan el consumo o el deterioro del medio ambiente (por ejemplo, los aplicados a los combustibles) y los impuestos recurrentes sobre bienes inmuebles», apuntan las recomendaciones que la UE dirige al Gobierno de Mariano Rajoy. La reforma fiscal debe asimismo eliminar las deducciones «ineficientes» en el impuesto de sociedades y el impuesto sobre la renta, así como «considerar la posibilidad de reducir las cotizaciones empresariales a la seguridad social, en particular en el caso de los empleos con salarios reducidos». Finalmente, España tiene que «tomar medidas para evitar que la fiscalidad obstaculice el funcionamiento armonioso del mercado interior español» e «intensificar la lucha contra la evasión fiscal». Reducir diferencias de coste de despido En cuanto al mercado laboral, España, según resaltan las recomendaciones, debe «impulsar nuevas medidas para reducir la segmentación del mercado de trabajo en aras de la calidad y sostenibilidad del empleo, en particular reduciendo el número de tipos de contrato y garantizando un acceso equilibrado a los derechos en caso de despido», así como «reforzar los requisitos de búsqueda de empleo para la percepción de las prestaciones por desempleo». «La segmentación continúa siendo un problema importante del mercado de trabajo español, siguen existiendo numerosos tipos de contrato y la diferencia entre los costes de despido de los contratos temporales y los indefinidos figura todavía, incluso tras la reforma (laboral de 2012) entre las más elevadas de la UE», alerta el texto. El Ecofin reclama que «la evolución de los salarios reales sea coherente con el objetivo de creación de empleo». También sugiere «mejorar la eficacia y la orientación de las políticas activas del mercado de trabajo, incluidas las bonificaciones ofrecidas por la contratación, sobre todo para quienes tienen más dificultades para acceder al empleo». El Gobierno de Mariano Rajoy tiene que «acelerar la modernización de los servicios públicos de empleo» y «garantizar la aplicación eficaz, antes de finales de 2014, de las iniciativas de cooperación entre los sectores público y privado en los servicios de colocación». Y poner en marcha la garantía juvenil para proporcionar a los menores de 25 años en paro o que finalizan su educación un empleo, prácticas o formación adicional en un plazo de cuatro meses. Revisión del gasto público 182

El Ecofin reclama al Gobierno de Mariano Rajoy «realizar, antes de febrero de 2015, una revisión sistemática del gasto en todos los niveles de la Administración para contribuir a mejorar la eficiencia y la calidad del gasto público». En concreto, deberá «seguir aumentando la eficiencia del sector de la asistencia sanitaria, sobre todo incrementando la racionalización del gasto farmacéutico, particularmente en los hospitales». Para los ministros, la estrategia presupuestaria de España en los próximos años «se ajusta sólo en parte a los requisitos del Pacto de Estabilidad». Las previsiones de crecimiento del Gobierno son plausibles para 2014 (1,2%), pero presentan «riesgos de sobreestimación» para 2015 (1,8%) y son «un tanto optimistas» para 2016 y 2017. «Así pues, existen también riesgos de sobreestimación en relación con las sendas de ajuste del déficit y la deuda», avisan las conclusiones. El Ecofin reclama al Gobierno que aplique «de forma rigurosa y transparente en todos los niveles de la administración las medidas preventivas, correctoras y coercitivas previstas en la Ley de Estabilidad Presupuestaria, incluidas las relativas a la eliminación de las deudas contraídas con entidades comerciales». Déficit eléctrico y rescate de autopistas La UE exige además a las autoridades españolas «garantizar la eliminación efectiva del déficit del sector eléctrico a partir de 2014, tomando, en su caso, las medidas estructurales adicionales necesarias». También recomienda «abordar el problema de las autopistas de peaje insolventes de modo que se minimicen los costes para el Estado», así como «establecer, antes de finales de 2014, un observatorio independiente que contribuya a la evaluación de los grandes proyectos futuros de infraestructura». España debe aplicar la reforma de las administraciones públicas, así como reforzar los mecanismos de control e incrementar la transparencia de las decisiones administrativas, en particular a nivel local y regional», así como «completar y supervisar cuidadosamente las medidas en curso para luchar contra la economía sumergida y el trabajo no declarado». Ley de servicios profesionales Otra prioridad para la UE es «aprobar una reforma ambiciosa de los servicios profesionales y de las asociaciones profesionales antes de finales de 2014, definiendo las profesiones que exigen la inscripción en un colegio profesional, así como las normas de transparencia y rendición de cuentas de los organismos profesionales, liberalizando las actividades reservadas injustificadamente y preservando la unidad de mercado en el acceso a los servicios profesionales y su ejercicio en España». El Gobierno tiene que tomar medidas para «reducir el tiempo, el coste y el número de trámites necesarios para establecer y poner en funcionamiento una empresa» y «corregir las restricciones injustificadas al establecimiento de grandes superficies comerciales, en concreto mediante la revisión de las disposiciones regionales de urbanismo». El Ecofin reclama además «completar la reforma del sector de las cajas de ahorro» y «finalizar la reestructuración de las cajas de ahorro de titularidad pública, con el fin de acelerar su plena recuperación y facilitar su vuelta a manos privadas». El Gobierno debería «fomentar los esfuerzos desplegados por los bancos para mantener ratios sólidas de capital y supervisar la actividad de la Sareb para garantizar que los activos se enajenen en los plazos establecidos, minimizando simultáneamente el coste para el contribuyente». http://www.abc.es/economia/20140619/abci-ecofin-pedira-espana-rebajar-201406181701.html 183

RealTime Economic Issues Watch

Argentina’s Debts: US Supreme Court Sets New Ground Rules for Sovereign Debt Management Worldwide by Anna Gelpern | June 17th, 2014 | 01:14 pm On Monday, June 16, the US Supreme Court rang the curtain down on two key parts of the drama surrounding Argentina and its creditors, which had dragged on since the country’s debt default in 2001. First, the Court refused [pdf] to review decisions by the federal appeals court for the Second Circuit in New York, ordering Argentina to pay creditors holding defaulted bonds in full whenever it pays its new restructured bonds. The next payment on the restructured bonds is scheduled for June 30. Second, in a separate case involving the same parties, argued before the Supreme Court in April, the Court ruled 7–1 to let creditors subpoena banks for information about Argentina’s assets around the world—even if these assets later turn out to be immune from seizure by the courts. The opinion was written by Justice Scalia; [pdf] Justice Ginsburg was the lone dissenter. Justice Sotomayor took no part in either decision. The first decision pointedly ignored interventions by Brazil, France, Mexico, Euroclear, the Jubilee Movement, and Nobel Laureate Joseph Stiglitz, among others. The second decision rejected arguments by the United States about the potential harm of allowing creditors unfettered discovery. The two decisions together highlight the limits of US courts’ tolerance of foreign governments using sovereignty to avoid their contracts. However the decisions do not guarantee that the creditors would be paid. Instead, they bless a debt enforcement regime that relies on sanctioning third parties who deal with the sovereign in default. This new regime is based on the idea that dealing with a defaulted sovereign will become so risky and expensive that it is simply not worth it. As a result, the country will become a financial pariah, unable to do basic financial business outside its borders. In sum, the decisions leave the prevailing system for sovereign debt management badly shaken. What happens between Argentina and its creditors from now on is not nearly as important as the way in which the international financial system adapts to the new reality. In this new reality, governments trying to restructure New York–law debt contracts have less scope to threaten default. In the past, a government could tell creditors that if they did not accept its restructuring offer, they could be stuck in default without recourse. After the Supreme Court refused to disturb the Second Circuit decisions, a government launching a debt restructuring should expect creditors who refuse to try blocking payments to the participating creditors. Participating creditors will worry that their payments might be blocked, and will seek compensation for the risk. Pending litigation against Grenada may limit this risk to a subset of debtors, but not yet.

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After the Supreme Court decisions, financial market service providers have become sovereign debt enforcement agents. Clearinghouses, banks, trustees, and fiscal agents in and outside the United States dealing with a government in default under its New York debt contracts should expect orders and subpoenas targeting the sovereign’s assets and activities anywhere and everywhere. Creditors who previously held unenforceable debt now have a promising tool to sanction a defaulting sovereign, though this does not guarantee that they will collect what they are owed. If dealing with a sovereign in default is a headache for market participants, many will avoid it, or will charge more for it. The result is an effective boycott. It becomes so costly for a sovereign to live a normal financial life outside its borders that it just pays up. As with any boycott, the pain threshold is in large part a function of domestic politics. In sum, Argentina and its most determined creditors have destabilized the sovereign debt management system, which has relied on informal customs, ad-hoc problem solving, and sovereign immunity in lieu of sovereign bankruptcy. It remains unclear how the system will adapt to a world where sovereign debt is enforceable, albeit indirectly, by threatening to harm a wide range of third parties. To be sure, Argentina and its creditors will keep fighting smaller battles in the lower federal courts for the next few months. These will have to do with timing (when will the court order payments to holdout creditors?) and Argentina’s attempts to get around the injunction to keep paying the restructured bonds—something President Cristina Fernandez de Kirchner promised to do again in her speech reacting to the decision. The timetable has become much more compressed. Federal courts at all levels have lost patience. The trial judge may now require Argentina to pay everyone by June 30 or soon thereafter, with no appetite to intervene to protect Argentina up the appellate chain. There is similarly no indication that US courts would allow Argentina to reroute its bond payments outside the United States to avoid the injunctions. The sympathy well ran dry a long time ago. All the third parties who might help Argentina do the rerouting have been warned. In the past, Argentina had threatened to default on all its debt rather than pay the holdouts. It might still do so, though the damage to its economy would be enormous. The government’s recent settlements with investors in utilities and other creditors suggest that Argentina is more likely to settle with the bond holdouts as well. It would be hard-pressed to settle with the plaintiffs in the one case decided by the courts, however. They are owed less than $1.5 billion, while leaving close to $15 billion in similarly situated holdout debt hanging. Any deal would have to reassure the markets that all the holdout litigation is put to bed—which means settling closer to $15 billion in claims, rather than $1.5 billion. Argentina’s reserves were under $30 billion [pdf] in April, which means that any large settlement would have to be in bonds. Such a transaction would take time to design and execute, and Argentina is just about out of time. Perhaps most important, there is no time for a face-saving political transition that would allow the current president to exit the stage and for her successor to do what she had sworn not to. The time pressure might raise the risk of inadvertent default. Financial market service providers may in the future change their contracts and policies to limit the risk of getting caught up in another Argentina-style mess. They could demand more indemnities from governments and their creditors, but these would not be 185

too useful when the government is in default. The better way is to refuse to handle contracts exposing them to litigation, and to have clear exit procedures if the risk materializes. Meanwhile, the International Monetary Fund (IMF), the G-7 governments, and others in the official sector should rethink their reliance on sovereign immunity for sovereign debt restructuring. The most likely policy response will be to encourage more contract reform, to limit opportunities for Argentina-style disruption. The IMF plans a paper on contract reform shortly (a companion paper on debt restructuring policy was discussed last week). A major trade group has floated a contract reform proposal within the past year. More may come. As with any contract change, transition looms large. It is implausible that all sovereigns will exchange all their outstanding bonds for ones with new, less vulnerable terms. Thus the fallout from Second Circuit decisions will continue until the existing debt stock runs off. On the other hand, courts in the United Kingdom, Belgium, and elsewhere are in a bind. They are not bound by the US decisions, but cannot ignore the highest court in the United States blessing a contract interpretation and a remedy that might conflict with their own jurisprudence, [pdf] or, in the case of Belgium, with national legislation shielding the Euroclear system [pdf] from the kinds of remedies issued by the New York courts. It will be interesting to see how they resolve the conflicts. The next month or two will bring more noisy Argentina news. But the full ramifications of Argentina’s crisis and default for the global financial system are coming into focus at long last. We have a glimpse of the sovereign debt world after Argentina. [pdf] It is a world fraught with uncertainty, perhaps more so than at any time since the early 1990s. On the other hand, the Supreme Court decisions also present an opportunity for market participants and policymakers to design a better framework for sovereign debt management, one that does not rely entirely on unenforceable contracts. A version of this essay was posted on Credit Slips. http://blogs.piie.com/realtime/?p=4353#.U6KarteIMtQ.twitter

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Daily Morning Newsbriefing June 18, 2014 Renzi backs Juncker – a blocking minority is now out of reach Herman van Rompuy visits Rome today for consultations with Matteo Renzi on Jean- Claude Juncker’s nomination as Commission president. La Repubblica reports that Renzi had a long telephone conversation with François Hollande to align their position on this matter ahead of today’s meeting with van Rompuy. Corriere writes that Renzi has no wish to be an obstacle to Juncker, provided he can get the deal he wants: a prominent Italian post in the Commission, and support for his agenda. The paper writes that this position has also been coordinated with President Giorgio Napolitano. It is hard to overestimate the importance of Renzi’s U-turn. If you do the maths on QMV in the European Council (see here for a calculator), you find David Cameron would have needed to secure the support of Italy, the Netherlands, Sweden and Hungary to block Juncker. Without Italy, there is no chance. James Landale made the point on the BBC News last night that David Cameron was officially still pretending to fight against Juncker, but that Downing Street was now becoming resigned to the idea that they might lose. We also noted Luke Baker’s tweet (@LukeReuters): “In the end, will historians draw clear line between Cameron's first concession to backbenchers on #EU, debacle over Juncker and #Brexit?” Corriere della Sera, meanwhile, has more details on the Italian plan for the EU presidency. It consists of four parts. 1. Using the room for manoeuvre in the existing treaties to bring about more fiscal flexibility; 2. a new political economy agenda focused on growth and financial stability; 3. a co-ordinated stance on immigration; 4. a more effective external policy. In his conversations with Napolitano – who seems to pull the strings right now – they agreed that the economy and immigration issues should be prioritised. The Corriere della Sera article makes the point that Italy was not seeking special favours, but wants a more favourable treatment of investments and structural reforms. In its Article IV consultations, the IMF yesterday underlined the precariousness of Italy’s situation. Italy was emerging from its recession, but very slowly because of tight credit conditions. The recommendations are the usual suspects of economic reforms, financial reforms, and fiscal consolidation. Deloitte risks losing licence over its audit of Bankia The Accounting and Audit Institute (ICAC) of Spain’s economy ministry has concluded a year-long investigation into Deloitte’s role as external auditor in the floating of Bankia 187

on the stock exchange three years ago, barely 10 months before its eventual failure which precipitated Spain’s banking rescue. According to El Confidencial, the ICAC finds that Deloitte committed a “very serious” breach of independence for which penalties go up to losing the licence to operate in Spain. According to the ICAC, Deloitte suffered from conflicts of interest as in addition to auditor it acted as a consultant to Bankia on diverse matters including the IPO itself. In addition, Deloitte is said to have committed “serious” infractions of “auditing norms” in relation with the “negligent” preparation of consolidated accounts of Bankia, which is the result of the merger of Caja Madrid, Bancaja and five other smaller cajas. Deloitte has been fighting these conclusions for nearly a year since the preliminary report of ICAC was known, and at the end of last year it obtained a short-lived court injunction seeking to stay the ICAC’s administrative procedure until after the court case on the failure of Bankia (where Deloitte is not a defendant) is decided. The auditor has also argued that the findings are “technicalities” and can still file allegations against ICAC’s conclusions. The current CEO of Bankia, José Ignacio Goirigolzarri, yesterday came to the defence of Deloitte arguing that the alleged violations do not materially affect the accounting, and highlighting the “professionality” of the auditor since he took over the bank two years ago. Spain’s economy minister Luis de Guindos has taken advantage of the controversy to announce his intention to reform of Spain’s audit law to tighten the regulations on conflict of interest, introduce an obligation to change auditors every 10 years, and strengthen the internal audit function of firms. With Cyprus the last bailout country returns to the bond markets Cyprus will issue its first public post-bailout bond today, the press talks about a five- year bond with a yield of around 5%, which should give enough margin to ensure success, Reuters quotes one of the bankers from the deal. The main reference for this new benchmark issuance is the Greek five-year bond, which had been sold at 4.95% in April, tighter than initial price thoughts of 5%-5.25% and was quoted 4.2% yesterday. The bond size is expected to be at least €500m according to the WSJ. This would be return to the market of the last programme country. French court of auditors expects deficit close to 4% The budget report of the court of auditors in France concludes that the French deficit risks being near or even above 4% of GDP this year if growth is less than forecast, Les Echos reports. The French government expects a growth rate of 1% in 2014, which now seems high says the court. Even if a 1% growth rate is realised, revenues could still be €2bn-€3bn less than the already downwardly revised estimates. On the expenditure side the court finds risks to be moderate, though there is no buffer against unexpected expenditures and unemployment insurance. Regional expenses could also turn out to be higher than expected. Against this background the court warns that the French government is set to miss the deficit target again this year, with a knock-on effect on the 2015-2017 budget trajectory. It also is sceptical about the deficit target of 3% for 2015, as revenues are likely to be less than expected but also because the government committed to an "ambitious" expenditure programme. The court finds that the expenditure targets in 2015 are based on the assumption of a "sharp decline in local investment and a very tight budget for the state." 188

But on the first point, nothing prevents communities to increase local taxes or borrow to increase their spending capacities. And on the second, the necessary savings require not just cuts but "profound reforms." The current reform on modernization of public action (MAP) "is still far from being up to this challenge." Greek government wavering The new Greek government seems to be wavering on decisions already taken, according to Kathimerini. Among the new ministers seeking a review of recent decisions are Education Minister Andreas Loverdos, who suggested that he could not enforce a budget that he himself had not voted for in Parliament. Also Interior Minister Argyris Dinopoulos appeared to make an overture to local authority employees protesting the mobility scheme, noting that their concern “is not unjustified.” Administrative staff at universities who have been affected by the mobility scheme are planning a fresh wave of action following a long strike last fall that paralyzed the higher education sector. The staff object to a government decision to rehire 600 staff who were put in a mobility scheme last year but to leave another 500 or so out of a job. The senate of Athens University described the new move as “very displeasing and a total reversal of everything that has been discussed and agreed over the past six months with the government,” condemning “the government’s inconceivable wavering,” Allies in Europe, opponents at home? We were a bit surprised to read this morning that the EP's liberal group ALDE has voted in favour of admitting the four MEPs from the Flemish seperatist party N-VA, should they apply to join, European Voice reports. ALDE group is led by Guy Verhofstadt, one of three Flemish liberal MEPs, who are political opponents of N-VA in Flanders, and it includes three MEPs from the francophone Belgian liberal party, Mouvement Réformateur (MR), who said they would vote against N-VA joining. But ALDE got the two third majority of its members it needed to accept the N-VA in the group. N-VA has already announced that it wants to leave the Greens/European Free Alliance, the group to which it is currently affiliated, but it has yet to decide where it might move to. The Flemish party will take a decision on group membership tomorrow (18 June). Verhofstadt was re-appointed unopposed as the ALDE group leader. No end of the recession yet - according to business cycle dating committee There is a juvenile way of looking at recessions (two quarters of falling growth), and there is an adult way, which is the approach also employed by NBER in the US, where a business cycle dating committee looks at a number of indicators and assess the start and the end of recessions. The CEPR has set up a similar committee for the eurozone – the Euro Area Business Cycle Dating Committee. And while we are in general sceptical of any committee with six words in its name – this has proved an immensely useful group because they are bring a lot more realism to our understanding of the business cycle. With a hat tip to the Wall Street Journal, we noted the Committee met on June 11, and concluded that it cannot call the end of the recession yet because there is no evidence of a sustained improvement of economic activity. Instead, they conclude that the eurozone may only be experiencing a pause in the recession that started after Q3 2011. Here is the recession chart from the CEPR’s press release. 189

Also note that the Germany ZEW indicator, a somewhat volatile indicator of the German economy, trended downwards again in June – against all expectations. ZEW noted that expectations had trended higher after the ECB’s June 5 announcements.

We agree, of course, with the methodology though we are wondering – as Jeff Frankel did before us – whether the 2008/2009 and post-2011 recessions were a single Great Recession –that was only briefly interrupted in 2010. The “two consecutive quarters” view of recessions is a shorthand model that is reasonably useful during a normal business cycle. It offers a lazy way to think about recessions. But it is not a definition of a recession. In the present business cycle, it is utterly misleading. EP analysis concludes European semester not working When the rules of the Maastricht Treaty and those of the stability pact were broken, the EU’s leadership concluded that the problem could easily be solved by adding even more rules to the existing ones. Frankfurter Allgemeine has discovered this morning – with an almost credible pretence of outrage – that the European semester is a joke. Countries ignore it just as they ignore all the other rules. The article was based on an analysis by the European Parliament, which the paper has obtained. Member states have realised less than 10% of the reforms. In last year’s European Semester, the Commission proposed a total of 141 reforms, of which twelve were carried out substantially, and only a single one was fully implemented. In 65 cases, there has been some progress, in 59 cases limited progress, and in four cases no progress. Italy and Germany were among the countries that have ignored several of the EU’s recommendations, while Spain has done a little better. Orphanides on politics vs economics in crisis resolution Athanasios Orphanides has published a research paper on the crisis, in which he castigates the dominance of politics over economics – which has led to crisis mismanagement. Specificially he found that “… member state governments tend to defend their own interests in a noncooperative manner. This has magnified the costs of the crisis and has resulted in an unbalanced and divisive incidence of the costs across the euro area.” Simon Wren-Lewis has a discussion in which he also discusses, and rejects, the extended claim (not made by Orphanides but by others) that Germany acted the way it

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did to reduce its own borrowing costs. On the Orphanides paper, Wren-Lewis concludes that he may have been too kind on economists, and too tough on politicians. We have never held back with our criticism of the crisis management, much of which is reflected in Orphanides’ paper. We agree with Orphanides’ analysis of non-cooperative behaviour of member states – a reflection of our own perception of a collective action problem. But we would caution against classifications of politics versus economics. Of course, any crisis resolution is political by definition. In a monetary union with an insufficient superstructure and no fiscal transfers, one would expect politics to reign supreme. For us the question is why has politics has ignored sound economic judgment? The imposition of austerity was a catastrophic error of economic judgement – the full horror of which will not become clear for several years. Non European economists and politicians saw this much more clearly. For us the conclusion would be to sharpen the economic analysis on which the institutions rely and to break with the supply-side dogma. Posen’s and Veron’s positive take on banking union Adam Posen and Nicolas Veron have a detailed analysis on banking union, and offer an upbeat “glass half full” assessment. In their article, they suggest three tests for the upcoming AQR/stress tests. “On the micro-prudential level, it will succeed if there is no equivalent case to Dexia in 2011 – meaning that insolvent cross-border banks get identified and resolved rather than having their problems put aside and allowed to accumulate; On the systemic stability level, it will succeed if credit growth to normal non-financial borrowers turns positive again after the AQR results and any recapitalisations; On the market level, it will succeed if there is greater differentiation of prices among bank equity and debt within any given national economy, and banks deemed sound are not excessively punished for their country of headquarters – i.e., a narrowing of spreads. Barring large external shocks to European financial stability, we expect this to have a more transformative impact on Europe’s financial and economic structures than many observers seem to realise. This impact should become evident along a number of dimensions.” We disagree, mostly. On the first criterion. Six years after Lehmann, the eurozone still has plenty of zombie banks, but no more Dexias. The stress tests will pass that hurdle – but even the flawed old stress tests would have passed it if they were applied today. We are reminded of Helmut Kohl’s “Gnade der spaeten Geburt”.On the credit growth argument: If the resumption of credit growth constitutes a test for the success of these policies, then the implicit assumption is that the fall in credit is predominantly a supply- side phenomenon. This is possibly, but not necessarily true. It is an issue that should at least be addressed. We agree with the third point on spreads. On the conclusion: We find it generally useful to set up criteria against which to measure exercises like these. One can then assess afterwards whether the tests have passed the tests. But why prejudice the outcome beforehand? Eurozone Financial Data 10y spreads

Previous Yesterday This

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day Morning France 0.376 0.373 0.365 Italy 1.439 1.423 1.417 Spain 1.323 1.313 1.303 Portugal 2.080 2.089 2.079 Greece 4.526 4.581 4.56 Ireland 1.046 1.043 1.039 Belgium 0.493 0.492 0.484 Bund Yield 1.354 1.404 1.41

exchange rates

This Previous morning Dollar 1.356 1.3545

Yen 138.370 138.48

Pound 0.800 0.7979

Swiss Franc 1.219 1.2184

ZC Inflation Swaps previous last close

1 yr 0.79 0.79

2 yr 0.88 0.88

5 yr 1.24 1.24

10 yr 1.66 1.66

Eonia

17-Jun-14 0.03

16-Jun-14 0.03

13-Jun-14 0.03

12-Jun-14 0.04

OIS yield curve

1W 0.037 15M 0.047 2W 0.067 18M 0.052 3W 0.040 21M 0.067 1M 0.052 2Y 0.078 2M 0.070 3Y 0.152 3M 0.074 4Y 0.280 4M 0.065 5Y 0.445 5M 0.055 6Y 0.623 6M 0.053 7Y 0.803

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7M 0.045 8Y 0.979 8M 0.043 9Y 1.138 9M 0.051 10Y 1.281 10M 0.050 15Y 1.783 11M 0.043 20Y 2.005 1Y 0.050 30Y 2.129

Euribor-OIS Spread previous last close

1 Week -0.143 -0.343

1 Month 5.457 4.157

3 Months 12.129 12.529

1 Year 38.600 38

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-06- 18.html?cHash=41b9a816828e8a3be9d00d445a573f82

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June 2014 - Euro Area Mired in Recession Pause The CEPR Euro Area Business Cycle Dating Committee establishes the chronology of recessions and expansions of the eleven original euro-area member countries plus Greece for 1970-1998, and of the euro area as a whole from 1999 onwards. The Committee met in London on 11 June 2014 to examine recent data developments and released its Findings on 16 June. The Committee observed that since early 2013 the euro area has witnessed a prolonged episode of extremely weak growth in economic activity: Euro area GDP has risen by less than 1% from 2013Q1 to 2014Q1 and labour markets have shown little change over that period. Had the improvement in economic activity been more significant, it is likely that the Committee would have declared a trough in the euro area business cycle in early 2013, most likely in 2013Q1. The lack of evidence of sustained improvement of economic activity in the euro area does, however, preclude calling an end to the recession that started after 2011Q3. Rather, consistent with the concerns expressed by the Committee at its October 2013 meeting, the euro area may be experiencing since early 2013 a prolonged pause in the recession that started after 2011Q3. The decision of the Committee not to call an end the recession that started after 2011Q3 in spite of several quarters of positive (but weak) economic developments in the euro area illustrates that its identification of peaks and troughs does not follow a mechanical two-quarter rule for GDP (see FAQ).The Committee indeed assesses both the length and the strength of improvements in economic activity to document the sustained growth that it requires to call the end of a recession. The decision of the Committee does not reflect a negative forecast by the Committee of future growth prospects for the euro area, since the Committee does not forecast (see FAQ). The Committee had previously met in Paris on 9 October 2013. The decision of the Committee to convene was prompted by positive news stemming from a variety of sources (the European Commission, statistical agencies, forecasting institutions, international organizations, NowCasting.com) about economic activity in the euro area. The objective of this meeting was to determine whether there was enough evidence that the decline in economic activity that started after third quarter of 2011 had ended. The Committee decided that, while it is possible that the recession ended, neither the length nor the strength of the recovery is sufficient, as of 9 October 2013, to declare that the euro area has come out of recession. The Committee released its findings on 19 October. The Committee had declared on 15 November 2012 that economic activity in the euro area had peaked in the third quarter of 2011 and that the euro area had been in recession since then. The third quarter of 2011 marked the end of an expansion that began in the second quarter of 2009 and lasted 10 quarters. Although output increased 4.03 per cent from trough to peak, this was not enough to bring euro-area GDP back to its pre- financial crisis level: at the end of the expansion in 2011Q3, GDP was about 2% below

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its previous 2008Q1 peak. You can read the 15 November Press Release here and the corresponding Findings here. Previous announcements of the Committee can be found here. You can find a discussion of the methodology used by the Committee here, the sources of its data here, and frequently asked questions (FAQs) here. Chronology of Euro Area Business Cycles The Committee has identified nine peak and trough quarters since 1970:

Table 1. Peaks and Troughs

Date Peak/Trough Announcement Date Findings

2011Q3 Peak 15 November 2012 Available here

2009Q2 Trough 4 October 2010 Available here

2008Q1 Peak 31 March 2009 Available here

1993Q3 Trough 22 September 2003 Available here

1992Q1 Peak 22 September 2003 Available here

1982Q3 Trough 22 September 2003 Available here

1980Q1 Peak 22 September 2003 Available here

1975Q1 Trough 22 September 2003 Available here

1974Q3 Peak 22 September 2003 Available here

Therefore the euro area expanded until 1974. Since then there have been four complete cyclical episodes (recession followed by expansion) and it is too early to tell whether the recession that started after the third quarter of 2011 has ended. Periods of recession are indicated in grey, and periods of expansion in white in the figure below. Note: CEPR Recession shading for quarters follows the trough method used by FRED to compute NBER Recession Inndicators for the United States (see http://research.stlouisfed.org/fred2/series/USREC/downloaddata?cid=32262). It shows a recession from the period following the peak through the trough (i.e. the peak is not included in the recession shading, but the trough is). http://www.cepr.org/content/euro-area-business-cycle-dating-committee

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We’re All Macroprudentialists Now as Bubble Policy Dawns By Simon Kennedy - Jun 17, 2014 Thirty-five years ago this month, a U.K. central banker by the name of Peter Cooke was worrying about a surge in lending to developing countries. Could such capital flows eventually threaten overall economic growth and market stability? he asked as he chaired a June 28-29, 1979, meeting of international bank regulators. Could they pose a “macroprudential” problem? The term Cooke used and possibly coined describes an approach to assessing economic threats posed by the financial system, as in 2008 when the collapse of the U.S. subprime mortgage market sent shockwaves through the world economy. It comes full circle today when modern-day Bank of England officials debate whether to cool house prices, putting themselves in the vanguard of a central-banking revolution. Success for so-called macroprudential regulation would see policy makers deflate potential excesses by limiting access to credit, protecting economic expansions from burst bubbles or blunt interest-rate increases. The trouble is, the track record of such tools is at best mixed. “Central banks are doing a lot on macropru right now,”said Gavyn Davies, chairman of London-based hedge fund firm Fulcrum Asset Management LLP. “The basic lesson from past attempts is, they haven’t worked for very long and they haven’t worked very well, so we have to do better than we have in the past.” Today’s Meeting Bank of England Governor Mark Carney is poised to act today as he chairs a meeting of the Financial Policy Committee amid concern that British house prices are getting out of control. London home values jumped an annual 18.7 percent in April, the most since July 2007, according to official data released today. The FPC “will not hesitate to take further proportionate and graduated action as warranted,” Carney wrote in a foreword to the bank’s annual report released today. “That will allowmonetary policy to remain focused on providing the stimulus the economy needs.” Having already toned down a credit-support measure, options include requiring a minimum for down payments for houses, making banks hold more capital against mortgage lending, toughening affordability tests, or telling the government to dilute its support of the market. Any decision will be announced next week. Carney Call “Once you get a housing bubble, you need to lean against it very hard and it takes a lot of tools,” said Adam Posen, a former BOE policy maker and now president of the Peterson Institute for International Economics in Washington.

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Investors may be underestimating just what the new instruments mean for them, said Brian Hilliard, an economist at Societe Generale SA in London. What he calls the “Carney Call’suggests regulators will be more willing than ever to act to avoid asset market excesses, effectively capping values. ‘‘Financial markets have not fully taken account of the implications of these new tools,’’ he said. It may be hard to gauge the right response though. While use of a regulatory tool could serve as a substitute for interest-rate increases and so push a currency down, it also could signal concern an economy is overheating which would tend to lift an exchange rate, strategists at HSBC Holdings Plc said in a report last week. The U.K. is not alone in its refashioning of economic policy after a two-decade global infatuation with inflation targeting. The flaws of that doctrine were exposed when the financial crisis rubbished the notion that if prices were stable, asset markets would be too. The fallout from the turmoil also challenged the notion that it was easier to clean up after a bubble popped than lean against one forming. Old Model ‘‘The old model in which central banks targeted inflationis one that paid too little attention to the financial system,’’said Rich Clarida, an executive vice president at Newport Beach, California-based Pacific Investment Management Co. The pressure for a new, two-pronged approach is also intensifying as weak inflation keeps major central banks such as the U.K’s reluctant to raise interest rates, even though many asset prices are surging. As well as rising house prices from Canada to Britain, the MSCI World Index of stocks is up almost a fifth from last year and yields on sovereign bonds to junk-rated company debt are at or near record lows. ‘‘It is a brave central banker who would deliberately induce a recession in order to head off the mere risk of a future financial correction,’’ Bank of England Deputy Governor Charlie Bean said in a May 20 speech. ‘‘That explains the interest in deploying additional policy instruments.’’ Nordic Policy While Bean noted a lack of experience on the matter, a track record is starting to form. Carney’s native Canada has been tightening macroprudential policy since 2008, with steps including minimum down-payment demands and maximum debt limits for insured mortgages. Sweden and Norway capped loans as a share of a property’s value and asked banks to protect themselves against losses. Hong Kong limited the size of loans too and took steps to curb some purchases by foreigners. New Zealand in October restricted the amount of new loans banks could issue to people with less than a 20 percent deposit, while Switzerland increased capital requirements and curbed mortgage maturities, among other measures. An April study of 20 nations by Goldman Sachs Group Inc. economist Hui Shan found that the total number of policies aimed at cooling housing has increased to an average of eight per year between 2007 and 2011 from one a year in the 1990s. So do the policies work? Shan found more restrictive policies cooled credit and house price growth by 1 percent annually. Banking regulation focused on mortgage lending

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was most effective in damping credit growth, while loan curbs best slowed house-price appreciation. ‘Speed Limit’ The Reserve Bank of New Zealand said in research last month that what it calls its ‘‘speed limit” had knocked around 3 percentage points off house-price inflation in the first six months. Hong Kong’s property market has also cooled after prices doubled since 2009. “There have been parts of the world where macroprudential policy has been quite effective,” said Karen Ward, a global economist at HSBC in London. “Not all have worked though, and it requires bold, timely and politically unfriendly judgments.” Some efforts may have succeeded only in preventing even worse outcomes. Most famously, the Bank of Spain greeted the millennium by requiring banks to boost reserves in anticipation of future write-offs for bad loans. It eased conditions in 2004, only for its real-estate market to later implode. Test Case That experience is unlikely to derail the macroprudential movement, and how Carney fares will be tracked by other key central banks such as the Federal Reserve and the European Central Bank. “He will be the test case,” said Posen. “The U.K. will be watched with interest.” Fed officials have raised financial-stability concerns at meetings in recent months. Among assets that have drawn the gaze of officials in speeches and minutes of meetings are premiums on longer-term debt, price-earnings ratios on some small capitalization stocks, declining credit quality on some high yield loans, and farmland values. Global policy makers are already seeking ways to gauge risk in much the same way they monitor economic indicators. The Bank for International Settlements proposes a role for the ratio of credit to gross domestic product, saying a deviation of what it calls the “credit gap” is a good early warning for banking troubles. ‘Too Pricey’ For the Group of Seven economies, that currently stands 8 percentage points below its long-term trend, according to the Washington-based Institute of International Finance. More worryingly, it estimates financial assets as a share of GDP are 9 percentage points higher than the trend. On real estate, the International Monetary Fund last week warned that ratios to rents and income “remain well above”historical averages for a majority of countries, and said housing is “still too pricey” in Belgium, Canada, Australia, New Zealand, France and the U.K. At Capital Economics Ltd. in London, economist Andrew Kenningham highlights various flaws in macroprudential policy. Authorities may struggle to spot bubbles, and efforts to pierce those they do see may run into political opposition, be circumvented or ignored by investors eager to buy a rising asset, he says. Central banks could also trust the new regulatory framework too much and end up leaving monetary policy overly loose, with“the perverse effect of making credit and asset bubbles more, rather than less, likely,” said Kenningham. 198

Monetary Policy Ultimately, central bankers may find old-fashioned monetary policy is still required, said Hung Tran, deputy managing director at the IIF. Recently departed Fed Governor Jeremy Steinsaid in February that unlike regulation, a change in rates“gets in all the cracks.” Carney said last week that“macroprudential policy is not a substitute for monetary policy.” “At same point, the consciousness for monetary policy to play a part will grow,” said Hung Tran. “There will be more central banks joining the debate.” http://www.bloomberg.com/news/2014-06-16/we-re-all-macroprudentialists-now-as- boe-tackles-bubbles.html

Europe’s half a banking union Published on June 15 2014, Summer 2014 Asked whether the EU’s banking union is a 'Potemkin Village' – the trompe l’oeil painted screens used to convince Catherine the Great of economic growth along

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the banks of the river Dnieper – Adam Posen and Nicolas Véron say "no, it’s real, but only half-built" Written by Adam S. Posen, President of the Peterson Institute for International Economics in Washington DC, & Nicolas Véron Senior fellow at Bruegel and visiting fellow at the Peterson Institute for International Economics in Washington DC Other articles by Adam S. Posen and Nicolas Véron ›

This spring, the EU institutions agreed a series of legislative texts that suggest bank closure decisions will be taken at the European level, not nationally. A Single Resolution Board will be established in Brussels as a new EU agency, and backed by a Single Bank Resolution Fund to be set up by separate treaty. These measures complement last year’s legislation for pooling the supervision of most of the EU’s banking sector by the European Central Bank (ECB) in Frankfurt. The link between European countries’ creditworthiness and that of banks headquartered in them still exists for a number of reasons. There’s limitations imposed on the Resolution Fund, the absence of common deposit insurance, and the insistence by some countries that so-called “legacy” bad debts cannot be paid for by common financial resources. In any event, it’s inevitable that some European taxpayers will again be finding themselves the unwilling victims of more banking failures, perhaps as soon as this autumn. Scepticism about Europe’s banking reforms should, however, end there. Decisions made so far on Europe’s banking union are significant, substantial, and likely to become entrenched. As we argued in June 2009 in a paper published by the Peterson Institute and Bruegel, a system-wide process of bank triage, forced recapitalisation where it was needed, and restructuring was the tried-and-tested way to resolve Europe’s systemic banking crisis, and to succeed it had to be done at the European rather than national level. “As always in European institutional development, the question is whether a half- measure of integration is helpful, or is too slow and even dangerously unstable” If adequately executed, the ECB’s Asset Quality Review (AQR) of the eurozone’s largest banks will provide a credible, though sadly belated, triage of the kind we proposed back then, if accompanied by the requisite resulting capital injections and restructurings. The early credibility of the AQR can be seen in banks’ widespread and

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substantial cutbacks in loan books, and the far fewer but still extant capital raising exercises, over the last few months to get their balance sheets ready. The starting point of Europe’s banking union was the eurozone summit statement of mid-2012, when EU leaders committed to: • “Break the vicious circle between banks and sovereigns”. • Centralise banking supervision at the ECB. • And use the recently-created European Stability Mechanism (ESM), for direct recapitalisation of individual banks, including those that were then in the process of being restructured in Spain under EU oversight. Until that statement, EU member states had defended their local control over banking policy as an unnegotiable attribute of national sovereignty. What can described as “banking nationalism” – a continued reliance on national policy instruments to defend and promote national banking champions in an increasingly integrated European financial market – can be identified as a key reason why the financial crisis of 2007-08 had such a severe impact on Europe, despite having started in the U.S. It also explains why, unlike in the U.S., European policymakers were unwilling to resolve it and were unable to rapidly re-establish trust in their banking system. Before the crisis, national authorities had encouraged “their” banks to grow so that they could become predators rather than prey in what most anticipated would be a wave of cross-border banking consolidation across Europe. This ambition came at the expense of prudence about systemic risk; between 2003 and 2008, the aggregate assets of Europe’s banks grew by the equivalent of almost the entire European GDP. The act symbolising this era was the takeover of the Dutch bank ABN Amro by a consortium of the UK-based Royal Bank of Scotland, the Belgium-based Fortis, and (after a follow-up transaction) Italy’s Monte dei Paschi di Siena. All three took on too much risk and debt for their own good in the process. They should have been discouraged from doing so by their respective home-country supervisors, but were not. All three acquiring banks then became costly failures, requiring fiscal bailouts and disrupting of credit flows. After the crisis erupted in the summer of 2007, banking nationalism again stood in the way of swift crisis management and resolution. It was a classic collective-action failure. Many national authorities knew there were weaknesses in “their” banks, but were unwilling to address them before neighbouring countries did likewise, as this could put their own local champions at a competitive disadvantage and maybe lead to their takeover by outsiders. This compounded the usual harmful incentives for bank supervisors to engage in forbearance, i.e. holding off on closing or forcibly merging regulated banks in the hope that an economic recovery (or the end of the supervisor’s term) would spare them from the need to do so. For each national authority, the incentive was thus to pretend that the extent of problem loans was not only exaggerated (while actually allowing them to increase), but also that the worst problems were outside of their own territorial remit (while going soft on supervision at home). This became all too apparent in the inadequate stress tests whose results were announced in September 2009, July 2010, and July 2011. Banks like Dexia were given a clean bill of health, only to collapse a few months later. Self-defeating supervisory behaviour is hardly unique to eurozone bank supervisors, but the escalation of such reality denial in the face of market panic and bank-sovereign doom loops in 2010-11 was the result of banking nationalism. 201

“Government talk is often cheap, witness the previous failed European bank stress tests, but our assessment is that European policymakers, including the ECB, have now made a credible commitment” Seen in this light, the banking union is a direct solution to the Maastricht treaty’s incompleteness in the banking area. The 1992 EU treaty combined a commitment to a single financial market and a single currency with a nationalistically-motivated refusal to integrate bank supervision and resolution at European level. It took Europe’s leaders five years of deepening credit collapse and financial crisis and a dramatic rise in Spanish and Italian sovereign spreads, plus the brief denial of access to dollar funding experienced by French banks in the summer of 2011, to realise that this combination was proving terminal. In late June 2012, with the single currency’s survival at stake and running out of options to prevent a break-up, they took the extraordinary but necessary step of effectively bidding farewell to banking nationalism. Perhaps inevitably, a combination of policy successes and setbacks marked initial implementation of the banking union commitment. An early disappointment came in mid-September 2012, when the finance ministers of Finland, Germany and the Netherlands issued a joint statement opposing any direct bank recapitalisation by the new European Stability Mechanism to bridge “legacy” capital gaps, i.e. losses on investments made by banks before the banking union. The statement reversed the prior agreement by those same countries’ at the EU’s June 2012 summit that the ESM would directly recapitalise Spanish banks, if only retroactively. That reversal understandably raised doubts about the northern euro members’ commitment to the entire banking union project. However, thanks to the announcement by the ECB of its Outright Monetary Transaction (OMT) commitment, as well as the justified belief that although legacy losses were finite, banking union would be forever, investor sentiment shifted to a new equilibrium that discounted the likelihood of a eurozone collapse. The establishment of the Single Supervisory Mechanism (SSM), however, was pursued with speed and determination. By December 2012, all member states agreed on draft legislation that empowered the ECB as the bank licensing authority for the whole “banking union area”, including the eurozone but also including any non-euro EU country that might join the banking union voluntarily. In a concession to the uniquely powerful German local-bank lobby, most smaller banks with balance sheets under €30bn were exempted from direct supervision by the ECB. But that low threshold still leaves the vast majority of the banking union’s banking assets, including almost all German Landesbanks and other mid-sized institutions, under the ECB’s immediate authority. Furthermore, the ECB has room to expand its remit and retains ultimate licensing authority over all credit institutions. The ECB also gained enforceable access to information from supervised banks, and the legislation makes it practically impossible for individual national authorities to obstruct ECB supervisory processes. Despite the delays resulting from the subsequent negotiation with the European Parliament, and various procedural roadblocks by Berlin during Germany’s pre-election period, the SSM Regulation of October 2013 stands out as a swift and comprehensive pooling of sovereignty with few equivalents in the whole history of the EU. More recently, the EU adopted a Bank Recovery and Resolution Directive together with the Single Resolution Mechanism, in principle paving the way towards a future in which the resolution of insolvent institutions would be conducted at European level and would minimise recourse to public funding. Unlike the SSM, the Single Resolution

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Board will be single in name only, as the legislation that sets it up foresees a significant degree of lingering autonomy for national resolution authorities. “With supervision now meaningfully integrated within the ECB, centralised resolution on the right path but even though not yet there, and common deposit insurance sadly off-limits, it is fair to label the current legislative arrangements ‘half a banking union’. Other progress has been made towards a banking union, though not all changes were equally comprehensive. The adoption of the Capital Requirements Regulation in June 2013 was a significant step towards having a “single rulebook” that the ECB could enforce uniformly across the banking union area, even though it regrettably deviated from the Basel III accord on several important points. Simultaneously, countries including France and Germany adopted idiosyncratic national laws on the separation of activities within banking groups, which conflicted with their stated commitment to the banking union. The most worrying gap remaining is that the unification of deposit insurance within the euro or banking union area has not even been broached by political leaders. This is understandable in the absence of a fiscal union that could credibly back it, but its absence underscores the dangers of incompleteness, a good example having been the huge movements of savings across borders after Ireland’s unilateral extension of deposit insurance in 2008. With supervision now meaningfully integrated within the ECB, centralised resolution on the right path even though not yet there, and common deposit insurance sadly off- limits, it is fair to label the current legislative arrangements a “half a banking union”. It is much more than a small step on the journey towards eliminating the vicious circle between banks and sovereigns, but it’s still incomplete. As always in European institutional development, the question is whether a half-measure of integration is helpful, or is too slow and even dangerously unstable. Our view is that in the case of half a banking union, this is sufficient progress to be meaningful and of a stabilising nature. As we argued in 2009, to end the European banking crisis required the strict testing of bank solvency by a European-level authority using a unified and transparent standard. The half a banking union meets these criteria. Crucially, the key transition step was put into motion by Article 33(4) of the SSM Regulation, which mandates the ECB “to carry out a comprehensive assessment, including a balance-sheet assessment, of the credit institutions” which it would start directly supervising in November 2014. The importance of this process, now widely referred to as the Asset Quality Review (AQR), has become ever more obvious during the course of 2013. It amounts to a massive front-loading of the ECB’s supervisory effort by a near-term deadline that is now approaching. This requirement creates large operational as well as political challenges, but to its credit the ECB is taking them on. One can hardly imagine the ECB granting or confirming a banking license to a bank that it wouldn’t consider insolvent – and the many past failures of national supervisors imply that the ECB could not base its initial supervisory assessment only on their respective opinions. Most importantly of all, the AQR holds the promise of putting an end to the systemic banking fragility that has affected Europe since mid-2007. It is now possible to be confident that the AQR will be more robust and credible than the previous European stress tests. The ECB will have direct access to bank information that was unavailable to the Committee of European Banking Supervisors (CEBS) in 2009 and 2010, and to its successor the European Banking Authority (EBA) in 2011. As the future supervisor, it will be able to demand much more co-operation from both 203

banks and national authorities, and it has the legal means to enforce its information requests. It has a much larger staff than had the CEBS or EBA, and in addition can rely on armies of consultants and auditors. But given that the previous European stress tests ended in policy failure, just this comparative statement of capabilities may not be enough to guarantee that the AQR will be certain of success. Nor can the success or failure of the AQR be demonstrated simply by either zero forced recapitalisations, which is likely to mean too soft an approach, or by some pre-set target number of banks being compelled to fail, which would be likely to indicate arbitrary political decisions rather than by supervisory assessment. In essence, the AQR should be deemed successful if three criteria are met: • On the micro-prudential level, it will succeed if there is no equivalent case to Dexia in 2011 – meaning that insolvent cross-border banks get identified and resolved rather than having their problems put aside and allowed to accumulate; • On the systemic stability level, it will succeed if credit growth to normal nonfinancial borrowers turns positive again after the AQR results and any recapitalisations; • On the market level, it will succeed if there is greater differentiation of prices among bank equity and debt within any given national economy, and banks deemed sound are not excessively punished for their country of headquarters – i.e., a narrowing of spreads. Not all of this will be revealed immediately at the time of announcement of the AQR results, expected in October, but we expect there will be many indications within a short period of time thereafter. The ECB’s approach appears, reasonably, to be to incentivise banks to act ahead of this deadline, to write down any dubious assets, and to recapitalise proactively to the extent needed, as Italy’s UniCredit and Intesa Sanpaolo and Germany’s Deutsche Bank have announced. But pre-emptive capital-raising is unlikely to be feasible for the weaker banks, which may fail to convince investors to buy newly issued capital instruments, and may also be unable to sell distressed assets at prices high enough to bridge their capital gap. Problem banks of this sort will need restructuring or resolution by national public authorities, as ESM direct recapitalisation is unavailable for “legacy” situations, and the Single Resolution Board won’t yet exist when the AQR results are announced. For the AQR to succeed, the ECB must not flinch at naming problem banks, and the relevant member states must address them in a manner consistent with their policy commitments, including the new state aid rules issued last year by the European Commission that restrict the potential for overt or covert bank bailouts. The fact that lending has been falling even as the euro’s growth prospects have been improving and government interest rates have declined is evidence that the banks subject to the AQR have been taking this threat as credible, and are raising their ratio of capital to loans. And the self-separation of those banks that can raise sufficient capital from those that cannot is further evidence, as well as progress on our third criterion. “The gradual emergence of truly pan-European banking groups will create a powerful interest in favour of the gradual elimination of countless cross-border competitive distortions and onerous national “gold-plating” of the EU single rulebook” Against this yardstick, our expectation is that the AQR will be broadly, if perhaps not entirely, successful. There could still be a failure of nerve by the ECB to see this

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through, or an unwillingness of a national resolution authority to do its job, but we believe this is unlikely to be on a large enough scale to compromise the whole exercise. Such a failure would have major negative consequences for the ECB, the eurozone and the EU as a whole, which would become apparent in markets almost immediately. The point of public pre-commitment is to make the costs of reneging so high that carrying out an obviously unpleasant duty nevertheless becomes a matter of self-interest. Government talk is often cheap, witness the previous failed European bank stress tests, but our assessment is that European policymakers, including the ECB, have now made a credible commitment. They have burnt their bridges and cannot retreat. Assuming a successful AQR, the European half a banking union will become a reality, offering a reasonably clean and well-capitalised starting point for the vast majority of the banking union area’s bank assets and all of its large credit institutions. Barring large external shocks to European financial stability, we expect this to have a more transformative impact on Europe’s financial and economic structures than many observers seem to realise. This impact should become evident along a number of dimensions: • Credit crunch resolution: A successful and complete AQR would trigger the return of trust in Europe’s banks, and an end to balance sheet contraction in those banks. This will improve retail credit conditions, particularly in the European periphery, thus reducing a major drag on economic growth and employment. A reliable signal of a return to normality would be growth in bank lending to small and medium- sized enterprises, with reduced spreads between lenders from different member states. On the policy side, this would allow an exit from the Eurosystem’s extraordinary liquidity provision programme to banks, known as fixed-rate full allotment, which has been in place since October 2008. • Stricter supervision: Unhampered by banking nationalism, the ECB is likely to be a more demanding and less forbearing supervisor than the national authorities it will supersede. This will apply to supervisory practice, but we expect it will also improve regulation. Compared with national authorities from the eurozone in the recent past, the ECB will not resist as much the strengthening of regulatory standards at the Basel Committee and in EU rulemaking processes, even though it may still champion advantages for European banks in international discussions. • Fewer taxpayer-funded bailouts: As banking nationalism was a major driver of the EU preference for public bailouts during the first five years of financial crisis, the shift of supervisory authority to the ECB lends credibility to the proclaimed objective of relying more on “bail-in” and financial burden-sharing by creditors in future bank restructurings – even though systemic stability considerations would still justify a recourse to public financing in severe crisis scenarios. This in turn would further weaken the vicious circle between banks and sovereigns, a significant part of which is the anticipation of nationally-funded bank rescues. • More cross-border financial integration within the banking union area: The ECB will have no incentive to discourage cross-border entry and acquisitions, as national authorities have done time and again in spite of formal commitments to the EU single market. In turn, the gradual emergence of truly pan-European banking groups will create a powerful interest in favour of the gradual elimination of countless cross- border competitive distortions and onerous national “gold-plating” of the EU single rulebook. In this new political economy, Europe’s banking market may become more 205

open to entry by non-European-headquartered banks, including into retail market segments, or at least more open to pressure on this front. • The reduced dominance of banking in European finance: So far, banks have remained uniquely dominant in Europe’s financial system when compared to other developed economies. One reason is the protection they have enjoyed from public authorities against potential competition from alternative credit channels, again motivated consciously or not by banking nationalism. The ECB has indicated it would take a much more sanguine view of the growth of market-based finance and non-bank financial intermediaries. Together with the previous point, this might contribute to a more diverse European financial ecosystem that could prove both more supportive of growth and employment, and more resilient in the face of systemic risk. • A lower home bias in sovereign debt portfolios: The large holdings of home- country sovereign debt by a number of banks, particularly in periphery countries, have powerfully contributed to the eurozone’s bank-sovereign vicious circle. A large part of these holdings result from so-called moral suasion, or non-public arm-twisting, by national authorities on the banks they supervise to help finance “their” national government. The ECB is unlikely to have any interest in exerting this. • A new balance in external representation: The ECB and other European-level agencies such as European Securities and Markets Authority and the Single Resolution Board can be expected to gradually gain prominence, in comparison to national authorities in banking union area countries, in international bodies such as the Financial Stability Board, the Basel Committee and the International Organization of Securities Commissions. Many things could still go wrong for European financial stability. The ECB could become too prescriptive on the corporate governance and business models of supervised banks, leading to a damaging erosion of diversity in banking structures within the banking union area. Political confrontation between European and national authorities over resolution of a given bank could prove damaging to the sustainability of the whole framework, at least in the early stages. Conflicts of jurisdiction may appear. The divide between the banking union area and the rest of the EU could prove damaging to the single market, and if (as is likely) some non-euro countries join the banking union, competitive distortions between these and the eurozone could arise. The exclusion of smaller banks and non-banks from direct supervision at European level could lead to harmful regulatory arbitrage. The reduced ability of member states to exert moral suasion over local banks will create political resistance to what reduces credit availability in dependent regions and sectors. But even with all these risks in mind, we are convinced that in terms of financial stability and beyond, the half a banking union that has been undertaken will be transformative and positive for the EU. Photo credit: Citizenside/Martyn Wheatley http://europesworld.org/2014/06/15/europes-half-a-banking-union/

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NHS is the world's best healthcare system, report says Study by Washington-based foundation says healthcare provision in the US is the worst in the world Denis Campbell and Nicholas Watt The Guardian, Tuesday 17 June 2014 20.27 BST

The intensive care unit at Royal Berkshire Hospital. Photograph: Martin Godwin for the Guardian The NHS has been declared the world's best healthcare system by an international panel of experts who rated its care superior to countries which spend far more on health. The same study also castigated healthcare provision in the US as the worst globally. Despite putting the most money into health, America denies care to many patients in need because they do not have health insurance and is also the poorest at saving the lives of people who fall ill, it found. The report has been produced by the Commonwealth Fund, a Washington-based foundation which is respected around the world for its analysis of the performance of different countries' health systems. It examined an array of evidence about performance in 11 countries, including detailed data from patients, doctors and the World Health Organisation. "The United Kingdom ranks first overall, scoring highest on quality, access and efficiency," the fund's researchers conclude in their 30-page report. Their findings amount to a huge endorsement of the health service, especially as it spends the second- lowest amount on healthcare among the 11 – just £2,008 per head, less than half the £5,017 in the US. Only New Zealand, with £1,876, spent less. In the Commonwealth Fund study the UK came first out of the 11 countries in eight of the 11 measures of care the authors looked at. It got top place on measures including 207

providing effective care, safe care, co-ordinated care and patient-centred care. The fund also rated the NHS as the best for giving access to care and for efficient use of resources. The only serious black mark against the NHS was its poor record on keeping people alive. On a composite "healthy lives" score, which includes deaths among infants and patients who would have survived had they received timely and effective healthcare, the UK came 10th. The authors say that the healthcare system cannot be solely blamed for this issue, which is strongly influenced by social and economic factors. Although the NHS came third overall for the timeliness of care, its "short waiting times" were praised. "There is a frequent misperception that trade-offs between universal coverage and timely access to specialised services are inevitable. However, the Netherlands, UK and Germany provide universal coverage with low out-of-pocket costs while maintaining quick access to speciality services," the report added. The NHS also outperforms the other countries – which include France, Germany and Canada – in managing the care of people who are chronically ill, the report said. Dr Mark Porter, leader of the doctors' union, the British Medical Association, said the fund's findings were "clear evidence that our much-maligned NHS is one of the top- performing healthcare systems in the world." However, he warned that the service's achievements were now at risk. "We should not be complacent as we are facing pressures that are threatening the high-quality care that the Commonwealth Fund has rightly praised. A combination of rising patient demand, staff shortages and falling funding is undermining the very foundations of the NHS, as is the constant short-term interference from politicians of all colours." Dr Peter Carter, chief executive of the Royal College of Nursing, said: "I'm absolutely thrilled to see this because it reinforces that this is a very good NHS, despite the fact that it has such a low level of funding relative to other countries." The health secretary, Jeremy Hunt, who has been criticised by some senior doctors for painting an unfairly negative picture of NHS staff and the quality of care provided, welcomed the report. "NHS staff work incredibly hard to care for patients and these encouraging results pay testament to that," he said. http://www.theguardian.com/society/2014/jun/17/nhs- health?CMP=EMCNEWEML6619I2

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Comment on macroeconomic issues

Monday, 16 June 2014 Does politics dominate economics in Eurozone crisis management? Athanasios Orphanides, leading academic macroeconomist and from 2007-12 Governor of the Central Bank of Cyprus, does not hold back in a recent paper. Here is just one quote: “During the crisis, key decision makers exhibited neither political leadership nor political courage. Rather than work towards containing total losses, politics led governments to focus on shifting losses to others. The result was massive destruction in some member states and a considerably higher total cost for Europe as a whole. European institutions could have been the last line of defense against this destructive dynamic but instead served to facilitate and enable the destruction.” His complaint will resonate with many from the smaller Eurozone economies. The text of the paper suggests that the way decisions are made in the Eurozone allows large countries to screw smaller countries, for short term economic gain, even if this damages the Eurozone as a whole. He focuses on two ‘blunders’. The first was the meeting between French President Sarkozy and German Chancellor Merkel in Deauville in 2010, where these leaders suggested that a haircut should be imposed on private sector lenders to solvent governments that got in to funding difficulties. Ireland lost market access for its debt within weeks. However Orphanides notes that German debt became less costly as a result. The second was in 2013, when the Eurogroup decided to impose a haircut on deposits of Cypriot banks, insured and uninsured. Although the decision was almost immediately recognised as a blunder, Orphanides justifiably asks how such a blunder could have been made. He suggests that it can be explained by the forthcoming German elections, and a need for the government to appear tough. The result was the destruction of Cypriot banks, which in turn gave Germany leverage to end the low Cypriot corporate tax rate. It has not escaped at least one reader of this paper that such decisions invariably favour Germany. This is not the message Orphanides highlights. The abstract says that the paper is about how politics has dominated economics in crisis management. But what exactly does that mean? And is it really the case that economics is blameless here? Take the Deauville decision. It is true that this hardly helped calm market nerves at the time, although Ashoka Mody arguesthat its impact on spreads was not that great. However it does seem to stretch credibility that this was a deliberate ploy by Germany to reduce its own borrowing costs. If it was, did Sarkozy also think it would reduce interest rates on French debt? A much more plausible explanation for this blunder is that

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Germany wanted to reintroduce some form of no bailout regime into the Eurozone. This may indeed have been a clumsy attempt to do so, but the real culprit was the absence of any clear economic mechanism that would allow the Eurozone to distinguish between sovereign debt crises where default was unavoidable, and sovereign debt crises which represented a self-fulfilling market panic, where the government’s fiscal position was in fact sustainable if support from other governments or institutions was forthcoming. This problem had not been addressed in the design of the Eurozone, under the pretence that the Stability and Growth Pact would mean that such issues would never arise. It has still not been addressed today: the problem has simply been shifted on to the shoulders of the ECB in consultation with governments, who have to jointly decide whether OMT will be invoked, and under what conditions. It remains unclear under what circumstances, if any, a Eurozone government will be left to default. It seems quite reasonable to argue in this case that politicians are left floundering, and make the occasional blunder, because the economics of the problem have not been thought through. Orphanides argues that“the domination of politics over economics has led to crisis mismanagement.” I suspect this is a little unfair on politics, and far too forgiving on economics. http://mainlymacro.blogspot.com.es/2014/06/does-politics-dominate-economics- in.html

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International Business Times UK EDITION David Cameron's EU Humiliation: 'The Die is Cast' over Juncker's EC President Appointment

By Nick Assinder Political Editor June 16, 2014 17:51 BST

Angela Merkel has been reportedly irritated by Cameron's campaigning.Reuters David Cameron appears to be heading for a humiliating and potentially damaging defeat in his campaign to stop Euro federalist Jean-Claude Juncker being appointed the new EU commission president. It is being claimed that the key player, Germany's Angela Merkel, has decided the issue must definitely be settled at the EU summit at the end of this month and, according to the Daily Telegraph, a confidential report has said that "the die is cast" in favour of Juncker. One source is reported to have told the Daily Telegraph: "She fears a nasty and toxic Britain versus Germany row the longer the debate goes on. "This means Merkel now wants to move very promptly to appointing Juncker at the latest at the European council at the end of the month. She has told Cameron this." According to the newspaper, a confidential report from a senior diplomat stated: "As matters stand now, (European Council president) Van Rompuy sees no alternative to the appointment of Juncker. Short of a complete U-turn by the Chancellor, the die is cast in Berlin." Related • Cameron's EU Chaos: Fresh Clashes With Merkel over Jean-Claude Juncker as Tory MEPs Go Rogue • Angela Merkel Rebukes David Cameron Over Demands to Block New EU Commission President • EU Presidential Candidate Juncker Hits Back at Cameron as Brussels Looks to a 'Kinnock' • Britain 'Could Quit EU' if Jean Claude Juncker is Elected President of the EU Commission 211

• Cameron Scrambles to Stop Federalist Winning Top EU Job After Polls 'Earthquake' At the same time, it is reported that one of Cameron's allies, Dutch prime minister Mark Rutte, is resigned to the appointment, declaring: "I can imagine Juncker will get it, though we're not there yet." The warnings come after the mini-summit last week in which Cameron warned against a "stitch up" to appoint Juncker and suggested it could intensify demands for Britain to pull out of the EU in an in-out referendum. It has been suggested that if Cameron fails to get his way, he will come under intense pressure from his own Eurosceptic MPs to bring forward the promised referendum. The prime minister set out his case in an article in a number of European newspapers, pointing out all three major UK parties are opposed to Juncker. And British diplomats repeated his warning at meetings during the summit. But, in the final press conference, Merkel voiced her irritation at the prime minister's public campaigning and warned him against making threats. Many in Westminster remain puzzled at Cameron's strategy which saw him declaring his opposition to Juncker early in the negotiations and, as a result, raising the stakes and making it more difficult for Merkel to compromise. If he fails, his backbench opponents are likely to turn on him with demands for an immediate in-out referendum and further battles with Brussels. If he gets his way it will represent a major victory and, he will hope, help silence his Tory Eurosceptic and Ukip critics at home. However there is a danger it could leave a legacy of bitterness amongst other EU states making future negotiations over Britain's membership more difficult. http://www.ibtimes.co.uk/david-camerons-eu-humiliation-die-cast-over-junckers-ec- president-appointment-1452912

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Tuesday 17 June 2014 'Die is cast' for Jean-Claude Juncker to take the EU's top job as defeat looms for David Cameron The "die is cast" for Jean-Claude Juncker's appointment as European Commission president after Angela Merkel turns on David Cameron amid British warnings of a looming political "train crash"

Mr Juncker was chosen as the leading candidate by the European People's Party Photo: BLOOMBERG By Bruno Waterfield, in Brussels and Peter Dominiczak 1:58PM BST 16 Jun 2014 British diplomats have warned that a "battle royal is coming" that could hasten a British referendum on Europe if the former prime minister of Luxembourg is installed in the European Union's top job. After talks between Herman Van Rompuy, the German Chancellor and Britain last week, Angela Merkel has decided "to proceed as soon as possible with the appointment" of Jean-Claude Juncker, inflicting a humiliating defeat on David Cameron at a meeting of EU leaders on June 27. "As matters stand now, Van Rompuy sees no alternative to the appointment of Juncker," said a confidential report, seen by The Telegraph of talks that took place last Wednesday. "Short of a complete U-turn by the Chancellor, the die is cast in Berlin." If Mr Juncker, an advocate of "ever closer union", is appointed, despite British opposition after a vote of European leaders in 10 days time, Mr Cameron faces a political backlash that could bring forward a referendum in Britain over whether to stay in the EU that is currently planned for 2017. Related Articles • Cameron’s lofty promises on Europe just don’t hold water 14 Jun 2014 • Juncker row splits the Tory party and piles pressure on Cameron 15 Jun 2014 • David Cameron tells Eurosceptics: trust me I get it 10 May 2014 • Ukip are the pro-Europeans' most dangerous weapon 18 May 2014 • New rift between Cameron and Merkel as rebel Tory MEPs recruit German Eurosceptics 12 Jun 2014

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During a diplomatic dinner in Brussels last Tuesday, Ivan Rogers, the UK's Permanent Representative to EU, warned that Britain would not accept the appointment of Mr Juncker. "He said that allowing the European Parliament rather that national governments to appoint the commission president is unacceptable and takes the EU to a different place. The UK would not accept the outcome of the process," said a senior European diplomat. Britain's most senior EU diplomat then went on to warn that Europe was "sleepwalking into an institutional crisis", political "dynamite" that could push the British towards the exit door. "He warned that Mr Juncker's appointment could accelerate a British referendum on leaving the EU and will completely change the political landscape," said the diplomat. "Rogers warned that the appointment could lead to dramatic events in July and that it should be a priority for the EU to avoid such a train crash." EU diplomats have been dismayed at British intransigence and Downing Street's refusal to hold any talks with Mr Juncker over his candidacy. British officials have used high-level European diplomat contacts to emphasise that the Conservatives, Liberal Democrats and Labour are united in opposition to Mr Juncker. In one recent discussion, the UK warned that only Nigel Farage's Ukip and other campaigners against EU membership would benefit from his appointment in Britain. Mr Juncker was chosen as the spitzenkandidat, or leading candidate, by the European People's Party (EPP), the biggest, centre-right grouping in the EU assembly, which is dominated by Mrs Merkel's Christian Democrats. MEPs, who have a veto over who is appointed, have insisted that Mr Juncker must be appointed to the job because the EPP won the most seats in European elections despite the fact its share of the vote fell and that over 90 per cent of voters did not know that he was a candidate. Mrs Merkel is known to be privately hostile to the process of appointing Mr Juncker but faces demands from within her coalition government that she recognises him as the "elected" candidate for the commission. According to European diplomats, Mrs Merkel has pushed for a quick appointment because she is concerned that the longer the row drags on, the more German support for Mr Juncker grows and becomes polarised with British public opinion against him. "She fears a nasty and toxic Britain versus Germany row the longer the debate goes on. This means Merkel now wants to move very promptly to appointing Juncker at the latest at the European Council at the end of the month. She has told Cameron this," said a senior diplomatic source. In a further blow for Mr Cameron, Mark Rutte, the Dutch prime minister, who has been a key ally in opposing Mr Juncker, signalled defeat. "I can imagine Juncker will get it, though we're not there yet," he said on Monday. Mats Persson, the director of Open Europe, said: "It's hard to see any winners from this apart from the minority cult in Brussels and some other places that see Spitzenkandidaten as the great democratic hope, the German Social Democrats who can use it to corner Merkel and, of course, those who want the UK to leave the EU."

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http://www.telegraph.co.uk/news/worldnews/europe/eu/10902893/Die-is-cast-for-Jean-Claude-Juncker- to-take-the-EUs-top-job-as-defeat-looms-for-David-Cameron.html

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Daily Morning Newsbriefing June 17, 2014 Gabriel supports Renzi’s agenda on fiscal rules While Angela Merkel was watching Germany trounce Portugal in Salvador de Bahia, the German vice chancellor Sigmar Gabriel visited France and questioned a central pillar of the German economic orthodoxy when he said he was open to give France and Italy some fiscal leeway for as long asthey are committed to reforms. Bloomberg quotes Gabriel as saying that France and Germany will present a proposal to the next European Commission to allow countries to subtract the cost of economic reforms from the budget deficit. The Franco-German proposal mainly targets France and Italy, Gabriel told a group of reporters in Toulouse. Gabriel also said that austerity had “failed." A new orientation of the European politics is required with more support for growth in its priorities and policies for the next five years. While Les Echos rejoices and welcomes the possibility of a new method of how deficits are calculated, Holger Stelzer writes in Frankfurter Allgemeine that in one strike Gabriel had destroyed the German position, which Merkel had carefully guarded during the crisis. According to Reuters the German finance ministry tried to play down the 'incident' with this statement: "Nobody in the federal government is calling into question the Stability and Growth Pact. The existing rules offer enough flexibility to enable growth-friendly consolidation. "It noted that the countries are already given more time to reduce their deficits. Michael Fuchs rejected any whitewash of the deficit figures and FDP leader Christian Lindner warned that loosening now would turn the eurozone into a debt-club, as FAZ reports. The economics ministry rejected that Gabriel put into question the stability pact. A statement says he only suggested more time for countries committed to reforms. The European election results showed that people feel left alone from the EU. It now needs to demonstrate that Europe is more than just about austerity and financial markets. Last week the IMF urged the EU to simplify fiscal rules and focus on cutting debt. Reza Moghadam said focusing mainly on debt would give EU governments the flexibility they need to keep their economies growing while retaining the confidence of markets and making the rules easier to explain to citizens. Barroso blames the Bank of Spain for the real estate bubble At a summer seminar on “Europe after the Crisis”, José Manuel Durâo Barroso highlighted the responsibility of the Bank of Spain in the banking crisis, as he said “very significant errors of supervision” were made in allowing especially the Cajas to blow a real state credit bubble, writes El País (English edition). Barroso referred to the BdE ironically as “the best central bank in the world”, and said the Commission questioned Spanish authorities about the Cajas during the bubble, but the answer was 216

always that they were healthy. He reiterated the view that “the crisis began in the US because of Lehman Brothers”, not in the Eurozone. Regarding Spain’s economic situation he admitted a “breach between macroeconomic data, social perception, and unemployment”. Barroso’s unusually strong attack on the Bank of Spain and Zapatero’s government for allowing private debt to get out of control has elicited a lot of commentary, mostly interested. There are those who attribute it to Barroso’s own need to sweep his own legacy of crisis management under the rug by focusing on the causes of the crisis. Others are happy to have one more stick to beat Zapatero with. Yet others defend the Bank of Spain by blurring the distinction between supervision and regulation and defending the latter including the introduction of countercyclical buffers. Finally, there are those who limit the problems to the Cajas, not the commercial banks, and accuse the fomer of having enjoyed unfair competitive advantages in the bubble years. Merkel and van Rompuy to propose Juncker We noted the story by the Volkskrant over the weekend that Herman van Rompuy has now concluded that only Jean-Claude Juncker can now be a candidate for the president of the European Commission. The Volkskrant obtained a diplomatic summary according to which Merkel agreed with that position. The risk of a British exit is considered as “collateral damage”, the paper quotes an official close to Merkel. The Dutch prime minister Mark Rutte was siding with Merkel. Merkel wants to conclude this quickly to avoid a toxic London-vs-Berlin type debate. The FT has a few more details from the summary of Merkel’s views. It, too, obtained a copy of the document, and said it was written by an EU diplomat, summerising Merkel’s views. “The chancellor made it very clear in the first meeting that she is facing increasing domestic pressure which now risks becoming damaging to her, and damaging to Europe…Her concerns are that the longer the debate goes on, the more toxic it is becoming, not least in the British tabloids.” The FT writes that Cameron still hoped that Rutte, Matteo Renzi, Fredrik Reinfeldt and Viktor Orbán would side with him. The article also reflected views within the UK that a Juncker appointment could push British public opinion closer towards an EU exit. This article said that the conclusions in the paper were not yet a final position. Von Rompuy has not concluded the consultations yet, and Merkel could still change her mind. But there is clearly no other candidate right now other than Juncker. The FT also a comment by Ivan Rogers, Britain’s representative to the EU, how said the EU was “sleepwalking into an institutional crisis”, adding ominously that “the UK [would not] accept the outcome of such a process”. In his Spiegel column, Wolfgang Munchau said Britain’s divorce from the EU is proceeding at a fast and increasing speed. Munchau writes that he, too, has reservations about Juncker, but the treaty is clear in that the European Council nominates, after consultations, and that the EP elects. These terms have precise meanings in constitutional law – to which British published opinion seems oblivious. He writes that the British political parties and the media have persistently 217

underestimated the parliament’s determination while overestimating their own ability to thwart this process. Munchau makes the further point that Britain’s divorce from the EU started with Maastricht and the subsequent exit from the ERM. The EU will not be able to contain a permanent non-eurozone group of members that pursue different interests. The EU exit debate is not really in or out. The UK is not in politically. The debate is about the much narrower question what legal form Britain’s detachment takes. We were quite struck by the list of the allies who might support Cameron. Renzi has doubts, but never said he would vote against Juncker. His own EU presidency starts in two weeks. He, too, has an overwhelming interest to conclude this issue this month, which would give him time to address the points that really matter to him – changes to the fiscal rules. As for Rutte, the Volkskrant writes that he sides with Merkel. That would leaves Cameron, Orban, and maybe Reinfeldt – all non eurozone interestingly. Even if they get Reinfeldt on board, they are still short of a blocking minority. It really would take all of the leaders listed in the article, especially Renzi. As for Merkel, it appears to us that Cameron and British commentators have misjudged her position. She is not going to take political risks for Britain. Stubb as PM will polarise the next election campaign On the LSE Europe blog Tapio Raunio argues that Alexander Stubb’s pro-EU views and desire to take Finland into NATO will set the background for the upcoming election campaign, with the Eurosceptic Finns Party in particular likely to lead opposition to the government. Party leader Timo Soini has done his best to distance his party from the more outright nationalist European parties. The Finns Party does not call for Finland’s exit from the EU or the Eurozone, believing instead that in the long run the EU will prove unworkable and will thus inevitably disintegrate. Raunio expects Soini to attack Stubb during the campaign, challenging his federalist and pro-NATO views. In a Eurosceptic country like Finland that might well be a winning strategy, he warns. Germany is shocked that a law it ratified is now applied We know this is a non-story because the rotation in the ECB’s governing council is laid down in the Lisbon Treaty, which was ratified by exactly the same people who are now screaming and pretend to be shocked. The issue is the vote rotation in the ECB’s governing council, starting January, when Germany and the other four large member states will have to take a back seat every five months. The outcry comes from Bavaria, and from the AfD, who are all proposing changes to give the large countries a permanent seat. For Germans to ask for treaty change on the ECB is a classic case of turkeys-voting-for- Christmas. Imaging the concessions they would have to make. The price stability mandate and the debt monetisation ban might be modified a little. So might then be the ECB’s independence. And for what? Italy, Spain and France would then also have a permanent seat. Would that make the ECB act more in Germany’s interests? Why is the non-eurozone again out-performing the eurozone? Matthew Dalton has an intriguing analysis in the Wall Street Journal, asking the question why the UK and Hungarian economies are now outperforming the eurozone – while not complying with EU recommendations. The article says Hungary has created a large public works program that generated 230,000 jobs over the past year, with unemployment down 3pp to under 8%. This was against the advice of the EU. The UK

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has also flouted the Commission’s exhortations on fiscal policy, which would have required more austerity (and which of course are not binding to the same extent as they would be for eurozone members). Eurostat, meanwhile, reports of an increase in the tax-to-GDP ratio in the eurozone from 39.5% in 2011 to 40.4% in 2012, with further estimated increased in 2013. This is essentially a measure of austerity applied to the eurozone. There is a clear eurozone- non-eurozone gap. In the UK, the tax to GDP ratio fell from 35.8% to 35.4%. The strongest relative increases were recorded in Hungary, Italy, Greece, France, Belgium and Luxembourg. Hungary thus does not fit the pattern – though note these data only cover 2011 and 2012. Dalton asks a good question. To which extent do EU rules constitute an impediment to economic growth? There is increasing evidence that the austerity policies have destroyed not only temporary growth but structural capacity that will never be recovered. EU countries outside the monetary union had more leeway in pursuing anti- cyclical policies. The persistence of large fiscal deficits were an important prerequisite for the UK’s economic recovery, plus, of course, a much more aggressive monetary policy. The eurozone has much tougher fiscal rules and a central bank with an asymmetric inflation target, that is now clearly willing to let the target slip. Spanish banks need additional provisions In an update on the European banking stress tests El Confidencial writes that three of Spain’s former cajas, Liberbank (which needed some help in the banking rescue), Ibercaja and Cajamar, are already in the process of raising capital in advance of their likely failing the stress test, despite the adverse scenario for Spain’s economic performance having been slightly relaxed. Even if overall capital ratios are sufficient, Spanish financial institutions are likely to need additional loss provisions for both their sovereign bond holdings and their real estate portfolios. In the latter case, the valuation made in 2012 by Oliver Wyman in the context of Spain’s banking rescue needed to be redone because the ECB is not accepting appraisals older than a year Nevertheless, the paper writes the real estate market has touched bottom and the new valuation is not expected to be too costly. As for sovereign debt, Spanish institutions sold at a profit (given the steep drop of yields since the height of the crisis) before closing the books for 2013 which is the AQR snapshot, only to repurchase the bonds in the first months of the year. Cinco Días writes, however, that the ECB intends to control the debt trading after the snapshot date in order to “avoid stress test results based on a fictitious situation” according to “sources aware of the ECB’s oversight plan”. The bond sale and repurchase may backfire on the banks because the AQR won’t stress the bonds held to maturity, but due to the balance sheet massaging most of the public debt is now in the trading book and will be subject to stress. Stress testing the stress test We noted two detailed comments on benchmarks for the AQR/stress tests to be credible. A stress test for the stress tests if you like. Ajai Chopra and Nicolas Véron of Bruegel want the ECB to separate the banks into three classes: “those that are sound without additional corrective measures; those that can be made viable with corrective measures; and those that are not viable and should be closed in 219

an orderly manner, which could include a merger with other strong banks. Kill the zombie banks, and heal the ones that are only wounded. Danièle Nouy, the euro area’s new chief supervisor, has acknowledged that some banks must disappear. Delivering on this will be critical.” Olaf Storbeck of Reuters Breaking Views writes that the tests could reveal some embarrassing problems among the Landesbanken. “Despite some downsizing and restructuring, many are still lacking a viable business model. Large exposures to risky assets in shipping and commercial real estate remain a danger. Some may struggle to pass the ECB's most adverse stress test scenario. And if they are forced to raise more capital, their subordinate bondholders could be hit, due to the EU’s state-aid rules. The ECB, as the euro zone’s new banking supervisor, should seize the moment and push for a radical restructuring of the sector. The six remaining Landesbanken can be consolidated into two institutions that would provide the wholesale financing for Germany’s savings banks. All other activities can we wound down.” It would be great to see the ECB to clean up the banking sector, and close down all those zombie banks, which include the Landesbanken. That alone would indeed vindicate the banking union. We would not exclude the possibility of a one or two token banks to be sacrificed as a PR stunt to underline the credibility of the exercise. But we would be surprised if the ECB could do to the Landesbanken what successive German governments could not, or that they could simply close down several Italian banks. Banking supervision is different from monetary union. With banking supervision the ECB has entered a political snakepit. Eurozone Financial Data 10y spreads

Previous This Yesterday day Morning France 0.370 0.376 0.380 Italy 1.422 1.436 1.438 Spain 1.298 1.323 1.329 Portugal 2.027 2.080 2.083 Greece 4.450 4.526 4.56 Ireland 1.042 1.046 1.053 Belgium 0.490 0.493 0.496 Bund Yield 1.367 1.354 1.352

exchange rates

This Previous morning Dollar 1.353 1.3562

Yen 137.840 138.21

Pound 0.797 0.7984

Swiss Franc 1.218 1.218

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ZC Inflation Swaps previous last close

1 yr 0.8 0.8

2 yr 0.89 0.89

5 yr 1.25 1.24

10 yr 1.66 1.66

Eonia

16-Jun-14 0.03

13-Jun-14 0.03

12-Jun-14 0.04

11-Jun-14 0.06

OIS yield curve

1W 0.020 15M 0.030 2W 0.019 18M 0.036 3W 0.027 21M 0.045 1M 0.035 2Y 0.063 2M 0.039 3Y 0.130 3M 0.044 4Y 0.249 4M 0.045 5Y 0.407 5M 0.042 6Y 0.585 6M 0.039 7Y 0.765 7M 0.038 8Y 0.935 8M 0.037 9Y 1.101 9M 0.037 10Y 1.238 10M 0.037 15Y 1.741 11M 0.037 20Y 1.963 1Y 0.037 30Y 2.090

Euribor-OIS Spread previous last close

1 Week 1.357 1.357

1 Month 7.871 7.671

3 Months 15.814 14.714

1 Year 40.357 42.457

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-06- 17.html?cHash=d81be36c79471b72ef6eec69d4674838

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The ECB’s bank review: Kill the Zombies and heal the wounded - complacency could still lead to another failed attempt to fix Europe’s banks, with severe consequences by Ajai Chopra and Nicolas Véron 16th June 2014 | The European Central Bank’s comprehensive assessment of euro area banks has had an encouraging start. But complacency could still lead to another failed attempt to fix Europe’s banks, with severe consequences. The ECB’s bank review looks like it will be more credible than the discredited EU-wide stress tests in 2010 and 2011. The ECB has its own reputation at stake, and has strong incentives to ensure that legacy problems are addressed before taking over from captured national authorities as the banks’ direct supervisor. Unlike earlier exercises, the assessment of banks’ soundness starts with an Asset Quality Review (AQR), which is an examination of the asset side of bank balance sheets as of the end of 2013. The exercise involves 128 banks and covers the vast majority of the euro area’s banking assets. Asset valuation adjustments following the AQR will feed into forward-looking stress tests factoring in adverse economic assumptions, on the basis of which the ECB will assess the banks’ capital shortfalls. Previously, banks and supervisors in different countries adopted different and often lax approaches to the valuation of assets, collateral and guarantees and to the classification of impaired loans. By using an army of auditors to assess non-performing exposures, collateral, and provisions, the AQR should enable the ECB to assemble and disseminate consistent information across banks and countries. In an encouraging sign, this exercise appears to have already spurred many banks to increase loan-loss provisions and capital. But the most critical part of the exercise still lies ahead, and could be harder than many investors and policymakers expect. The technical and logistical challenges alone are daunting, especially because the ECB is still building its staff and skills. In addition, national supervisors will still play a critical role. They can use their position on the new Supervisory Board within the ECB to promote the narrow interests of banks and authorities in their countries. For example, the published benign assumptions for the adverse scenario in the stress tests — such as only a mild decline in property prices in Ireland, or no allowance for deflation in countries such as Spain — were likely promoted by national authorities. Weak stress assumptions make it more difficult for the ECB reestablish trust that banks are sound. Another danger is that the results may not be disseminated quickly enough or in a transparent manner. The AQR is to be completed at the end of July, followed by the stress test, but the ECB does not intend any disclosures until late October, and may delay necessary supervisory actions beyond this date. But securities laws may require

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earlier disclosure of any discrepancy between previous and new estimates of capital, for example. In the absence of a common euro area backstop to protect market confidence, there is a further danger of regulatory forbearance in the form of understated capital needs. Many also fear that the ECB might single out problems in banks from smaller and less powerful countries in an attempt to make the exercise look credible, while papering over cracks in more powerful countries. Even in small countries, the ECB may hesitate to declare a bank insolvent if the national government appears unable to deal with it. Capital requirements may also be understated for technical reasons, because of the primary reliance on complex risk-weighted ratios that can be manipulated and because of the ECB’s own lack of deep accounting and valuation experience. Closing unviable banks and recapitalizing and restructuring viable ones are inherently painful and politically charged steps. Structures to manage failed banks and assets remain inadequate in Europe. In addition, domestic bank governance structures (e.g., the role of foundations in Italy, regional cooperatives that control Crédit Agricole in France, or public shareholders in Germany) could impede the ability to raise new capital. Before the EU’s Bank Recovery and Resolution Directive takes full effect in 2016, the policy stance toward forcing losses on (or bailing in) unsecured bank creditors if there is a capital shortfall remains unclear. Overcoming these handicaps is feasible but difficult. To maximize prospects for success, the ECB must first be prepared to mercilessly identify the weaker banks, including “zombie” banks that pretend to be sound, abetted by complicit national authorities. The AQR and stress tests should separate banks into three groups: those that are sound without additional corrective measures; those that can be made viable with corrective measures; and those that are not viable and should be closed in an orderly manner, which could include a merger with other strong banks. Kill the zombie banks, and heal the ones that are only wounded. Danièle Nouy, the euro area’s new chief supervisor, has acknowledged that some banks must disappear. Delivering on this will be critical. This policy does not imply a target big number for the aggregate capital gap for the euro area. The critical success factors will be rigor and evenhandedness in identifying capital shortfalls in core countries as well as the periphery, and not shying away from declaring banks to be insolvent. Encouragingly, independent estimates of the aggregate capital shortfall such as those by Viral Acharya and Sascha Steffen suggest that even if public backstops are needed, their magnitude will not likely damage sovereign debt sustainability. Transparency is essential. As Karl Whelan has pointed out, the standards must be higher than the cursory disclosure of AQR results by Irish banks in December 2013. Investors will want to know how supervisors deal with losses denied by banks claiming differences over asset classification or collateral valuation. Plans should be made to reduce the danger of chaotic dissemination of AQR results between July and October, emphasizing disclosure to provide uniformity and reduce unwarranted market turbulence. Although the stress test’s capital thresholds are defined in terms of risk- weighted assets, the disclosures should also include simple leverage ratios to provide a more complete judgment of whether banks are adequately capitalized. Finally, member states need to adopt a rigorous approach to rectifying capital shortfalls while minimizing cost to taxpayers. Orderly resolution of insolvent banks should 223

include writing down not only shareholders' equity but also hybrid instruments and subordinated debt. All member states that lack laws to do so should urgently enact them. Unsecured senior bonds should be “bailed in” to reduce the cost of resolving zombie banks. The corresponding requirements of the Bank Recovery and Resolution Directive do not come into full effect until 2016 and it is too late to amend EU legislation in time for the AQR results. Under these circumstances, a political agreement to adopt a common approach that imposes losses on unsecured senior creditors of zombie banks would avoid damaging divergence from one member state to another. Shareholders of wounded but viable banks needing increased capital buffers should not be rewarded until satisfactory capital levels are attained. In addition, banks unable to raise sufficient private capital should come under state aid rules, making conversion of junior debt to equity a condition for public assistance. In sum, restoring confidence and clarity and minimizing cost to taxpayers should trump protections for subordinated and senior bank debt. Closing dysfunctional zombie banks and restoring wounded ones to health will not be enough to pull the euro area out of its economic and political funk. But the hard work of recognizing bad loans and recapitalizing and restructuring banks will reduce the current drag on growth from banks that squeeze credit even from promising firms, and will contribute to economic expansion and employment. Europe’s policymakers need nerve and clear-sightedness for this opportunity not to be wasted. | Read more at Bruegel: http://www.bruegel.org/nc/blog/detail/article/1362-the-ecbs- bank-review-kill-the-zombies-and-heal-the-wounded/

EUROPE Déficit : le vice-chancelier allemand brise un tabou THIBAUT MADELIN / CORRESPONDANT A BERLIN |LE 16/06 A 19:34| Lu 1426 fois

Le ministre allemand de l’Economie, Sigmar Gabriel et son homologue français Arnaud Montebourg ont visité hier, ensemble, le site d’Airbus, à Toulouse. - AFP

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Le ministre de l’Economie allemand, le social-démocrate Sigmar Gabriel, a proposé hier de revoir le mode de calcul des déficits publics en excluant les dépenses liées aux réformes structurelles. Le ministre allemand de l’Economie a brisé un tabou hier en proposant une nouvelle interprétation du pacte de stabilité et de croissance. « Les coûts occasionnés par toutes les mesures de réforme ne devraient pas être pris en compte dans les critères de déficit », a déclaré Sigmar Gabriel, qui est aussi vice-chancelier, lors d’une visite du site d’Airbus à Toulouse avec son homologue français, Arnaud Montebourg. Actuellement, le seuil de déficit public autorisé en zone euro, soit 3 % du PIB, n’intègre pas le coût des réformes ou les mesures pour encourager la croissance. Sigmar Gabriel, qui reste flou sur les modalités d’une telle évolution, estime primordial de réduire les déficits, mais il veut « donner du temps aux pays décidés à mener des réformes » et souligne qu’il faut « tenir compte de l’emploi et de la croissance ».« Nous ne pouvons pas miser à 100 % sur une politique de rigueur », a assuré le ministre, qui est aussi président du Parti social-démocrate (SPD). Ses déclarations ont manifestement réjoui Arnaud Montebourg, qui a fait de la lutte contre l’austérité son cheval de bataille. Elles interviennent alors que la Commission européenne s’inquiète du déficit français, qui risque à nouveau de dépasser les 3 % l’année prochaine. Surtout, elles s’inscrivent dans un débat plus large sur la feuille de route de la prochaine Commission sur fond de chômage endémique dans le sud de l’Europe. Le débat évolue Ainsi, le président du Conseil italien, Matteo Renzi , voudrait exclure les grands investissements du calcul et a prévenu qu’il ne soutiendrait pas un président de la Commission européenne qui ne changerait pas de politique . En Allemagne, le ministre en charge des questions européennes, Michael Roth, lui aussi SPD, a proposé une interprétation allant dans le même sens. « Nous devons traiter les dépenses d’avenir dans l’éducation, la recherche, les infrastructures et l’emploi autrement que comme des dépenses de l’Etat, a-t-il déclaré lundi au “Handelsblatt”. Sinon, les pays endettés n’arriveront même plus à investir dans l’avenir. » Une position qui contraste avec celle du ministre des Finances chrétien-démocrate (CDU), Wolfgang Schäuble, pour qui le pacte de stabilité et de croissance est « suffisamment flexible »,selon sa porte-parole. Pour autant le débat évolue bel et bien outre-Rhin. « Les discussions ont lieu, mais en coulisse », observe une source bien informée. « J’ai l’impression qu’il y a à Berlin comme à Paris la même préoccupation d’une Europe qui crée plus de croissance et d’emploi, le même souci par rapport à la montée des populismes », selon Pierre Moscovici, l’ancien ministre des Finances, qui était à Berlin la semaine dernière En savoir plus sur http://www.lesechos.fr/monde/europe/0203569452523-deficit-le- vice-chancelier-allemand-brise-un-tabou-1013470.php?ftAYorZ8lDdiIPhs.99

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Tuesday, 17 June 2014 Only in Germany ECB could unmask incomplete Landesbanken cleanup 16 June 2014 | By Olaf Storbeck The ECB’s asset quality review and stress test could reveal some embarrassing weaknesses in the balance sheet of Germany’s Landesbanken. The regional lenders were among the worst casualties of the financial crisis. Despite some downsizing and restructuring, many are still lacking a viable business model. Large exposures to risky assets in shipping and commercial real estate remain a danger. Some may struggle to pass the ECB’s most adverse stress test scenario. And if they are forced to raise more capital, their subordinate bondholders could be hit, due to the EU’s state-aid rules. The ECB, as the euro zone’s new banking supervisor, should seize the moment and push for a radical restructuring of the sector. The six remaining Landesbanken can be consolidated into two institutions that would provide the wholesale financing for Germany’s savings banks. All other activities can we wound down. True, the Landesbanken are a minor headache when compared to the rest of the German banking sector, which is being propped up by the strength of the domestic economy, low unemployment, and the international success of the country’s companies. Their problems pale in comparison to the woes of the periphery’s ailing banks. According to Moody’s, the ratio of non-performing loans in Germany has fallen below 4 percent in 2013. It is at least twice as high in countries like Spain, Italy and Austria. Moreover, German banks aggressively shrunk their balance sheets in recent years. The Landesbanken, jointly owned by Germany’s regional states and local savings banks, account for slightly less than 20 percent of the banking system’s total assets. They did their part of that deleveraging. Since the financial crisis, they reduced their risk-weighted assets by almost 50 percent. Following pressure from Brussels, infamous WestLB was wound down. Stricken SachsenLB was merged into Landesbank Baden- Württemberg (LBBW), and Berliner Landesbank has embarked on a radical downsizing. But overall, the restructuring has been half-hearted at best. Many Landesbanken still lack a viable business model. They lost their old one a decade ago, when the European Commission banned their government backing. That cut off their access to cheap, subsidised liquidity. Today, the task of providing wholesale banking for the country’s regional savings banks requires one or two, rather than six, lenders overall – if the rival cooperative sector is an indication. That was the plan, but it failed due to political obstacles – as shown by the tentative merger of BayernLB and LBBW. Meanwhile, the Landesbanken left standing still haven’t found a viable long-term business model. Some are trying to focus on regional

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lending to small and medium-sized enterprises. But that’s a segment with ample competition from cooperatives and regional savings banks as well as the private sector. Moreover, lenders controlled by local politicians and supplied with the implicit backing of the taxpayers are likely to distort the market. The weaker players still need some form of government backing. HSH Nordbank, which in the pre-crisis years had risen to become the world’s largest shipping bank, was granted a guarantee worth 10 billion euros by the German states Schleswig-Holstein and Hamburg, who jointly own 85 percent. NordLB, another public lender with a big shipping portfolio, has increased risk provisions for those loans drastically, even though it says its Basel III phase-in capital ratio in the first quarter of 2014 stood at 11 percent. The Landesbanken increased their capital buffers mostly by hiving off assets. Raising additional capital, if needed, will be much harder. Landesbanken are the least profitable segment of the German banking system, Fitch data shows. So retaining earnings will not help beef up capital buffers. And due to their legal structure as unlisted public entities, they cannot tap the stock market either. Finally, a recapitalisation by the banks’ current owners is difficult. German regional governments are struggling with high levels of public debt and will not be keen to fork out the money – which will be highly unpopular. Moreover, the European Commission would have a say. The new state-aid rules give Brussels the right to insist on forcing haircuts on subordinate bondholders. Hybrid bonds, which can be converted into shares in a crisis and could be sold to private investors, are an option. But their launch in Germany was long delayed by tax issues that were only resolved in April. Given the short time frame, issuing convertible capital before the ECB’s asset quality review could prove a challenge for the smaller lenders. Unbiased and thorough scrutiny by Europe’s fledgling common banking watchdog could and should uncover the Landesbanken’s flaws. It might be embarrassing and painful for subordinate bondholders, but would be beneficial for the banking sector as a whole. As WestLB’s example has shown, external pressure is the most efficient tool to clean up a bloated and inefficient lender. Germany should embrace the opportunity. http://www.breakingviews.com/21151156.article?h=1c8f4459f27257b5ccdd85d97b599 bde&s=2

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The Wall Street Journal June 12, 2014 4:13 PM EU Budget-Rule Outliers Complicate Enforcement Hungary, U.K. Boast Two of Bloc's Best-Performing Economies

By Matthew Dalton The European Union has embraced an economic orthodoxy defined by tight budgets, anti-inflation central banking and limited government fiddling in the economy. But that orthodoxy is facing an uncomfortable fact: Two nations that have been challenging it in recent years—Hungary and the U.K.—now boast two of the 28-nation bloc's best-performing economies. Both countries have recorded some of the highest growth rates in the EU over the last three quarters. Unemployment in both has also fallen sharply over the past year. The good news has arrived despite poor economic performance across much of the rest of Europe. The developments come at a time when officials in Brussels are struggling to enforce new rules that, in theory at least, give them more power to set economic policies in EU member states. Hungary and the U.K., neither of which are in the euro zone, are among several governments fighting back against what they see as unwarranted intrusion into their

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political life by unelected officials at the European Commission, the EU's executive arm. In Hungary, Prime Minister Viktor Orban has installed political allies at the Hungarian central bank, culminating in last year's appointment of the economy minister to be its governor. Mr. Orban's government was repeatedly criticized by the European Central Bank and the commission for passing laws that gave the government more control over appointments at the bank, in what appeared to be a threat to its independence, a cherished principle in EU law. The moves resulted in a major shift in bank policy. After two years of steady or rising interest rates, they started to fall. In May, the bank cut again for the 22nd straight month. "We know low interest rates are better for growth than high interest rates," said Zsolt Darvas, a Hungarian economist at the Bruegel think tank in Brussels. "The real interest rate declined very significantly and that may have helped." Meanwhile, the government created a large public works program that provided tens of thousands of jobs. The program has helped create more than 230,000 jobs in all over the past year, economists say, cutting the unemployment rate by an impressive 3 percentage points, to under 8%. Last year, however, the commission in its annual recommendations to the member states said Hungary should "reduce the dominance of the public works scheme within employment measures." "The commission has rather costly ideas about what we should do about raising employment," said Gabor Orban, state secretary at the Hungarian Ministry of Economy, "and they've been ignoring the results of the system that we have up and running." Mr. Orban (no relation to the prime minister) acknowledges the program isn't a permanent solution to the country's unemployment woes. But he says there are signs that demand from the private sector is starting to pull workers out of the public employment program. "It's a labor pool that companies will increasingly draw from," he said. "It would not happen were these people sitting at home content with their social benefits." The commission continues to be wary of the public employment program. "The rise in employment in Hungary is of course welcome but it must be noted that this has been driven to a large degree by the subsidized public work scheme," said commission spokesman Simon O'Connor. "More structural reforms will be needed in order to lift employment in the open labor market." The U.K. too has enjoyed the benefits of a central bank that pulled out the stops to fight the recession with loose monetary policy, even as inflation ran consistently above its 2% target. Meanwhile, the U.K. government consistently ignored the bloc's budget rules over the last three years by running deficits that exceeded EU targets. In 2009, the EU told U.K. Prime Minister Gordon Brown to reduce his government's deficit, then over 11% of gross domestic product, to under 3% of GDP in fiscal year

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2014-2015, which began in April. The deficit is forecast to be 5% of GDP this fiscal year. The U.K. has an exemption from the threat of sanctions for ignoring EU economic rules. But it also has an obligation, albeit with no teeth, to manage its deficit in line with EU rules. Though U.K. Prime Minister David Cameron campaigned on an austerity budget, his government could have been forced to cut its budget by significantly more had it decided to abide by the EU rules. The commission's annual recommendations to the U.K., released last week said that the U.K. should have cut its structural balance—the actual balance of spending and revenue, adjusted for the strength of the economy and one-off measures—by roughly 70% more than it has over the previous five years. The experience of Hungary and the U.K. since the crisis highlights the perils facing the commission as it tries to take a bigger role in the economic policies of its member states. "If these were technicalities it wouldn't be an issue," Mr. Orban, the state secretary, said. "But many of their recommendations go to the heart of our political agenda." Write to Matthew Dalton at [email protected]

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ft.com Comment Analysis June 16, 2014 7:35 pm Into the shadows: Taking another path By Patrick Jenkins and Sam Fleming Shadow banking offers potential benefits and challenges as it goes mainstream

©Corbis When Jean-Pierre Mustier thinks about shadow banking, he remembers the “dark” days before the 2008 financial crisis. Back then, the term captured much of what was bad about the financial system – banks pushing chunks of loans through unsupervised “structured investment vehicles” and other exotic off-balance sheet entities designed to dodge rules on excessive risk taking. “Before the crisis, there was a lot of ‘dark’ shadow banking, in the realm of SIVs and ‘conduits’ which was largely about regulatory arbitrage,” says the former investment banking boss at France’s Société Générale. More ON THIS STORY// Fed looks at exit fees on bond funds/ Comment Make shadow banks safe/ Banking Weekly shadow banks, payday lenders and return of the CDS/ Analysis Risky business, global threat/ Comment Time to focus a light on shadow banking ON THIS TOPIC// ‘Patient capital’ ready for bank retreat/ Smart Money Do not be fooled by fund rankings/ Markets Insight Mutual funds pose no systemic risk/ Citic extends exposure to shadow banking IN ANALYSIS// Financial markets Hurrah before the storm/ UK politics Labour and the City/ Thailand Salute to the past/ World Cup Pitch battle Despite the complexity of the shadow banking system, the outcome of its collapse was frighteningly simple. About $400bn worth of subprime loans and other assets that had been coursing through the shadow banking system shrank to zero in a matter of weeks, leaving banks and other investors with huge losses that magnified the impact of the crisis around the world. Mr Mustier witnessed it firsthand: SocGen was one of the 231

dozens of banks in Europe and the US that was brought to the brink of collapse by the crisis. Today, though, the softly spoken Frenchman, who now works in a similar role at Italy’s UniCredit, is convinced that shadow banking is a force for good. “Now it’s more about banks being disintermediated. It’s ‘light’ shadow banking. What’s going on today is like good cholesterol as opposed to the bad cholesterol we had before.” Mr Mustier is on one side of a hotly contested debate between those who believe shadow banking is a useful engine of growth and those convinced that, for the second time in a decade, it poses a dangerous risk to the global financial system. Either way, the upheaval will force companies and individuals to rethink their financial affairs, and regulators to reform the way they monitor the global financial system. Already, shadow financing has supplanted much of traditional banking in China, worrying some policy makers in the country. Dramatic changes are also being felt in other parts of the world. In Europe, there are signs that a structural shift is under way towards a US-style model of corporate finance that relies less on bank loans and more on bond funding and other non-bank alternatives. In the US, the shadow banking activity that characterised the pre- crisis era is well below former levels. But in other areas, such as non-bank lending through “business development companies”, it has exploded in size and scope. “There is a vast restructuring of the financial landscape under way,” says Lord Davies, a former banker and UK government minister turned private equity executive. “We’re at a tipping point now where banks are shedding more and more assets. There is a real rethink of what is a bank, what is an insurance company, what is a hedge fund, what is a private equity firm. Over the next 10 or 15 years, what was shadow banking will become mainstream.”

Much of the activity is happening in London and involves lending by a range of non- banks, from start-up crowdfunded boutiques to insurance companies. “Direct lending is the talk of the town,” says Paul Watters, head of corporate research at Standard & Poor’s, the credit rating agency. The tale of London entrepreneur Charlotte Knight is typical. Armed a few years ago with a concoction of beetroot and mint and a spicy red pepper sauce, Ms Knight quit a

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high-flying career at Cisco and launched G’Nosh. The mission was to disrupt the British market for gourmet dips and ready meals, and the business has prospered. But when an expansion put pressure on her cash flow, Ms Knight did her bit to shake up the banking industry. “I’m passionate about good food and cooking. But I’m a big fan of disruptive technologies, too,” she says. So when it came to trying to accelerate her customer receipts, she shunned Lloyds, her long-time bank, and sought invoice financing instead from Market Invoice, an upstart crowdfunded online lender. Paying a discount rate of about 1.5 per cent, a quarter of the normal bank rate, Ms Knight now uses the service to turn invoices outstanding with the likes of Ocado and Co-op into quick, ready cash. “It’s efficient and affordable,” she says. “I get a steady stream of £20,000 a month, with funds released within 24 hours.” Peer-to-peer (P2P) lending of this kind is the visible tip of the shadow banking iceberg, made up – depending on whose definition is used – of insurers, pension funds, asset managers, hedge funds, specialist boutiques, broker dealers, exchange traded funds and money market mutual funds, all engaged in a range of activities that used to be performed by banks. Difficult to define It should be no surprise, then, that the size of the shadow banking industry is difficult to pin down. Global regulators at the Financial Stability Board calculate that the industry ballooned from assets of $26.1tn in 2002 to $71.2tn a decade later – equivalent to a quarter of the world’s total financial system. Although the boom and bust in SIVs and conduits inflated the number in the pre-crisis years, the total has continued to grow as other forms of shadow banking have taken their place. But any attempt to quantify this fast-moving, loosely defined sector is fraught with problems. Even the FSB admits as much. Its best guess after narrowing its definition to exclude spurious “non-bank-like activity” leaves a $35tn industry. What is clear, however, is that shadow banking is expanding, and fast.

And behind that growth lies a crucial driver: regulators’ clampdown on the banking sector, in particular the tougher capital requirements on riskier assets. Those rules have

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discouraged banks from doing much of the business that they used to, leaving other firms to pick up the slack. “Finance is a shape shifter that is capable of converting itself in any number of ways at any time,” says Paul Tucker, former deputy governor at the Bank of England and a leader in the attempt to co-ordinate an international regulatory response to shadow banking. The opportunity is underpinned by alluring potential rewards. Non-banks such as private equity funds and hedge funds have been keen to invest in the potentially higher- yielding assets the banks are shedding – from cut-price bundles of mortgages or leveraged loans to complicated structured finance instruments – as a way to boost returns amid perennially low interest rates. Assisting the shadow banks in their effort to go mainstream has been a steady flow of top executives from traditional banks. The career paths of a succession of right-hand men to Jamie Dimon, JPMorgan chief executive, tell the tale. The latest exit, in March, was that of Mike Cavanagh, who left for private equity house Carlyle. Before him Jes Staley quit to join hedge fund Blue Mountain. And before him, Bill Winters set up his own boutique fund, Renshaw Bay. “The demands and pressures of running big banks these days are unappealing,” says Lord Davies, now vice-chairman of US private equity firm Corsair. “Shadow institutions are less onerously regulated and they’re more entrepreneurial.” Going global If shadow banking was a US-centric activity before the financial crisis, it is now a global phenomenon. Some of the clearest evidence of the move away from traditional lending is emerging in the eurozone. Under pressure from the crisis, banks have shrunk their assets by close to €3tn, or 8 per cent, and further deleveraging is widely expected, making way for others. The Bank of England says that, while bank lending has declined since 2009, there was “a growing use of non-bank finance by SMEs, albeit from low levels, including peer-to-peer lending, crowdfunding and venture capital funds”. European financiers are convinced that the continent’s historical reliance on traditional bank finance is giving way to a more US-like model. Insurers including Allianz, Axa and Generali, are extending loans to SMEs. In London, firms ranging from start-up boutiques to mainstream fund managers such as M&G are boosting their lending. Omni Partners, a UK hedge fund, is offering short-term property loans as a way to exploit the “very big hole” banks have left in the market. “We can advance you several million pounds in three days from a standing start,” says Steve Clark, the founder. “That is the length of time it would have taken you to get an appointment with a bank relationship manager.” Given the usefulness of this type of gap-filling activity, some in the business say it is about time “shadow banking” was given a less pejorative name. Mr Winters likes to talk about “non-bank financial institutions”, while others favour “direct lenders” or “market- based finance”. Tony James, president of private equity firm Blackstone, says: “Putting that [negative] definition of shadow banks out there is dangerous for the market. Distributing that risk is essential for banks to free up capital, because without it they would not lend money.”

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Beyond straightforward corporate lending, however, there still exist more aggressive forms of shadow banking. Some investment bankers and niche hedge funds are involved in the contentious area of regulatory capital arbitrage. Christofferson Robb in the US and Chenavari in the UK specialise in the area, while Renshaw Bay has also dabbled in it. Yet even here, financiers insist that there is a genuine and transparent transfer of risk away from the banks, something that the most egregious arbitrage activity of the pre- crisis years did not properly facilitate. Darwinist financial commentators hail all the change in the market as evidence of the vibrancy of capitalism. But for every enthusiast who applauds the economic imperative of ersatz banks, there is a sceptic who warns of the dangers, with particular concerns regarding oversight. Assessing the risk When Paul McCulley, an economist and former managing director at fund manager Pimco, coined the term “shadow banking” in 2007, he defined it as “ a levered-up financial intermediary” whose liabilities were perceived to have the same qualities as conventional bank deposits. It quickly became shorthand for obscure regulation- dodging structures. The industry has evolved since then, but it remains by its very nature outside the scope of mainstream regulation. Part of its raison d'être is arbitraging the regulated banking system. Money market funds are clearly the largest risk in the system by sheer volume - Bill Winters, who set up boutique fund Renshaw Bay Money market funds are a case in point. This $2.6tn sector is such a staple of the US financial system that many Americans would raise an eyebrow to hear the funds labelled shadow banks – but they are precisely that. After taking off in the 1970s as a way around bank regulation, they were considered to be ultra-safe quasi-deposits by retail and corporate customers alike. This myth was exposed when Lehman Brothers’ commercial paper, held by one fund, defaulted, triggering panic across the sector and forcing the US government to introduce a temporary guarantee on money market investments. “Money market funds are clearly the largest risk in the system by sheer volume,” says Mr Winters. “Regulators have moved in the direction of treating these bank-like institutions more like banks, but they are not being hit hard [by regulators] because the lobby behind them – some of the biggest financial companies in the world – is so ferocious.” The risks posed by the escalating size and complexity of the shadow banking market are a big concern for global regulators. They are keenly aware that such activity is prospering in part because of the tougher constraints they imposed on mainstream banking to make it safer. They now need robust ways of regulating shadow banking, too. For the FSB, the umbrella body for the world’s regulators, pinning down the shadow banking industry – not just its scale, but its shifting nature and the risks it poses to the world – is a top priority. 235

But it must first decide what a systemically important shadow bank looks like. Mr Tucker, now a Harvard academic, believes shadow banking should be defined as any activity that combines two of three characteristics: credit provision, maturity transformation (meaning that the institution borrows money for a shorter timeframe than it lends) and leverage (allowing it to gear up with debt). Conventional wisdom says that there is potential systemic risk only when leverage is involved through debt sourced from banks. But regulators are coming to realise that the established ways of thinking about shadow banking may be short-sighted. That approach ignores, for example, risks created by the shift of commodity trading away from banks, for which capital requirements have become uneconomic, and towards lightly regulated trading firms such as Glencore Xstrata and Trafigura. Similarly, there will be a build-up of risk in central counterparty (CCP) clearing houses, following the regulatory drive to reroute banks’ trading activities via CCPs and exchanges. An elusive target Policy makers such as Mark Carney, governor of the Bank of England and head of the FSB, argue that some shadow banks will have to be supervised more like banks. The BoE is re-examining the UK’s regulatory “perimeter” to assess whether some shadow banks need to be brought into the scope of mainstream regulation. In a significant move towards bringing shadow banks into the fold, the BoE said last week that it would extend its liquidity facilities to some non-banks – specifically big broker-dealers and central counterparties. Mr Carney has made it clear that he sees shadow banks as a potentially beneficial part of the financial ecosystem. He also says that bringing them into the mainstream will help contain risk in the system. That, of course, is likely to fuel a whole new process of financial sector reinvention. Bill White, the former chief economist at the Bank for International Settlements, says: “It seems to me that nobody on the regulatory side has really got to grips with the reality of this constant innovation.” Torn between the desire to match lenders and borrowers of all hues, yet create a safer system, policy makers face an uncomfortable truth: no matter where you direct the light, there will always be shadows. Additional reporting by Martin Arnold http://www.ft.com/intl/cms/s/0/8016fca4-e106-11e3-875f- 00144feabdc0.html#axzz34p9hUT9q

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ft.com Comment Opinion

June 16, 2014 7:20 pm Make shadow banks safe and private money sound By Paul McCulley The Fed is turning informal banking into a public-private partnership, says Paul McCulley The rise of the shadow bank – a kind of credit intermediary that lies outside the range of much banking regulation – carries a subtler corollary. It has created a kind of money that is likewise beyond reach of central bankers’ traditional instruments of oversight and control. Rightly, the US Federal Reserve is responding by forging new tools. Money created by governments comes in two forms. There is currency, the notes and coin you carry in your wallet; and there are reserves, balances held at the central bank by deposit-taking institutions. These liabilities always trade at par; a retail bank can reduce its reserves by $1m in return for receiving the same value in notes and coin from the central bank, just as you can exchange a dollar bill for four quarters. More ON THIS STORY// Fed looks at exit fees on bond funds/ Into the shadows Taking another path/ Banking Weekly shadow banks, payday lenders and return of the CDS/ Analysis Risky business, global threat/ Comment Time to focus a light on shadow banking ON THIS TOPIC// The Macro Sweep US manufacturing, India inflation/ Central banks shift into equities/ Outlook Strength of recovery in focus/ Financial markets Hurrah before the storm IN OPINION// China’s currency push/ Richard Haass A recast Middle East evolves/ Izabella Kaminska More work for the Turing test/ Nick Pearce School raids But money also comes in private forms. Deposits in retail banks are one example. Balances in money market funds are another. (These institutions are similar to banks, except that they raise funds in the money markets instead of taking it from private depositors; and they use the proceeds to buy bonds instead of extending loans.) This “private” money usually trades at par, too. You can exchange $20 in bank deposits for a $20 bill as quickly as you can reach a cash machine. As long as people expect this situation to continue, the system works well. But if confidence disappears, panic ensues, as happened time and again in the 1900s. Then came the creation of the Fed, which could lend to besieged institutions as a last resort to stop a run. Deposit insurance also prevented fears about the solvency of a bank from becoming self-fulfilling. Such backstops were needed to give the public confidence that banks would always be able to deliver on their promise to exchange deposits for cash. They turned banking into a public-private partnership. But they applied only to the formal banking sector. There were no similar protections for shadow banks.

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For most people, money is currency and insured deposits. These are the kinds of money included in the M2 monetary aggregate, which is closely followed by policy makers. But for asset managers and corporations, money begins where M2 ends. These economic actors must hold billions of dollars worth of liquid assets – far too much to keep in physical currency, and far larger than the maximum bank balance covered by government guarantees. Such behemoths must resort to other forms of money. Uninsured bank deposits are one option – but not an especially attractive one, since they are just unsecured and undiversified claims on banks. A better alternative is “shadow” money: balances in money market funds, for example, or repurchase agreements, also known as “repos”, in which a borrower sells a security and promises to buy it back at a predetermined price and time. What is under-appreciated is that those who hold such shadow money do so not out of choice but because they lack access to better alternatives. When this informal financial system seized up during the crisis, the response was to extend public backstops – this time to shadow banks, as well as hitherto uninsured deposits in regular ones. But these were temporary measures. Now the Fed has begun extending to shadow banks many of the same protections and controls that have been used to stabilise the formal banking sector for more than a century. The Fed’s new “reverse repo” (RRP) facility in effect gives shadow banks an account at the Fed, similar to the reserve accounts that deposit-taking institutions keep there. It conceptually gives the Fed a way to prevent excessive credit creation in the shadow banking sector. Regular banks are required to hold minimum levels of capital, placing a limit on the expansion of their loan books. The Fed could achieve a similar effect in the shadow banking sector by setting minimum “haircuts” – limits on the amount market participants can raise against safe assets such as Treasuries. This could give it a degree of macroprudential control it lacked pre-crisis, when haircuts became perfunctory. Similarly, just as regular banks are required to hold a certain level of reserves, so shadow banks could be forced to maintain minimum balances in the RRP. The facility could also enable the Fed to become a “dealer of last resort”, just as it is a lender of last resort to regular banks. This would ensure a troubled shadow bank could always find a counterparty in the market. The Fed ended up playing this role in 2008 but only hesitantly – for counterparties whose books it did not intimately know and for whom it did not maintain reserve accounts. The RRP will formalise both the oversight mechanism and the rescue procedure. The crisis of the past decade was a reminder of the instability inherent in private money. The Fed is taking vital steps towards turning shadow banking – and the shadow money it creates – into a public-private partnership, much as was done with regular banking 100 years ago. This is wise. Individuals and small businesses are not alone in needing a safe form of private money.

The writer is chief economist at Pimco. This piece was co-written by Zoltan Pozsar, a senior adviser at the US Treasury department http://www.ft.com/intl/cms/s/0/f5b30bce-f321-11e3-a3f8- 00144feabdc0.html#axzz34p9hUT9q

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ft.com Comment Analysis June 15, 2014 2:20 pm Into the shadows: risky business, global threat By Jamil Anderlini The first of an FT series investigates China’s precarious shadow banking system

From the window of his office, Qiao Jingshan can look out across downtown Yuncheng and see signs of new construction everywhere. Half-built or empty apartment complexes are scattered across the cityscape bearing names like “Eastar Upward”, “Golden Riverside” or “Stars and River Mansion”. As chief accountant for Yuncheng City Investment, a financing vehicle for the local government, Mr Qiao has played a crucial role in the development of this gritty steelmaking city in central China. His latest job is to sell his company’s “trust product” – a high-interest, deposit-like investment – with the proceeds going to a big public heating project for Yuncheng. More ON THIS STORY// Comment Time to focus a light on shadow banking/ Topics Shadow Banking/ China data point to stabilising economy/ Price rises pose dilemma for China easing/ Citic extends exposure to shadow banking ON THIS TOPIC// Shadow banks step into the lending void/ Slideshow Shadow banks step into the void/ Banks unload risk into blind pools/ ‘Patient capital’ ready for debt sell-off IN ANALYSIS// UK economy Smooth sailing?/ Into the shadows Taking another path/ Financial markets Hurrah before the storm/ UK politics Labour and the City Despite paying a tempting 9.7 per cent annual interest rate, his product, marketed as “Eternal Trust Number 37”, is not catching on with investors. Mr Qiao is worried.

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The problem could be that Yuncheng’s property market has hit a rough patch or that a local steel plant has closed. But he blames events outside Yuncheng for his predicament. The near-default of other Chinese financial products recently has set off alarms – inside China and in global markets – that the country is in the midst of a dangerous credit bubble. Mr Qiao admits the Yuncheng heating project will not provide any returns for his company, an unsettling fact for any investor. But he is dismissive that this is the problem. “All of our investments are public works that should actually be paid for by the local government so when the trust product matures the government should take this project off our hands and give us the money to repay investors,” he says. “Don’t worry, it is impossible for there to be any sort of financial crisis here in Yuncheng.” Trust products, such as the one offered by Yuncheng City Investment, lie at the heart of China’s shadow banking sector, which has provided more than Rmb30tn ($4.8tn) worth of loans to the country’s riskier enterprises since 2007. It has helped create the biggest credit boom in history. But in Yuncheng and scores of similar nondescript cities across the country, China’s enormous and poorly regulated shadow banking sector is starting to run into trouble, with profound implications for the world’s second-largest economy – and potentially the global economy. Today the Financial Times begins a series on how “shadow banking” – a term that covers a wide range of “non-bank” institutions that perform many of the functions of traditional banks, but do so outside the traditional system of regulated banks – is reshaping finance around the world. The last shadow banking bubble, in the US in the run-up to 2008, compounded the global crisis that followed. Now markets and regulators are concerned that the rapid build-up of risk in China’s shadow banking sector could inflict similar damage.

Worries about China’s shadow banking system rattled global stock markets this winter, after a wealth management product called “Credit Equals Gold” was reported to be on the verge of default. It was quickly restructured, only to be followed by concerns about a similar product known as “Opulent Blessing”. Although these were small products in relation to the Chinese economy, the financial markets – and regulators – paid attention. 240

Noting how large the sector has grown, many in China warn that the country could face its own “Lehman moment” if it were to see a serious run on shadow banks. The concern is that financing could disappear for the most leveraged and riskiest parts of the economy, from real estate developers to steel mills. China’s investment-reliant growth could come to an abrupt end. “The [traditional] banks have been very strategic about pushing their weakest assets into these channels,” says Charlene Chu, the former Fitch analyst who was one of the first to raise serious questions about the rise of China’s shadow banking sector and who now works for Autonomous, the research group. “The weakest institutions and creditors are the ones engaged in shadow banking, where bad decisions and bad risk management are the norm.” A necessary evil Yuncheng City Investment is one of more than 10,000 “local government financing vehicles” (LGFVs) set up by Communist party officials as a way to circumvent laws that forbid local governments from running deficits. Their job is to raise money any way they can and spend it on behalf of local authorities, often on public works projects such as roads, public heating or sewage systems. The latest official estimate puts the total amount of debt held by LGFVs at Rmb17.9tn by the middle of last year, equivalent to more than 31 per cent of China’s gross domestic product in 2013. Most LGFVs were created in the wake of the global financial crisis in late 2008, when Chinese exports fell off a cliff and the government launched an enormous stimulus plan to stave off economic disaster. The LGFVs were seen by Beijing as a necessary evil and were initially allowed to borrow directly from the country’s state-owned banks.

With Beijing exhorting companies and local governments to borrow and spend as much as they could, total debt to GDP in China’s economy rose from 130 per cent in 2008 to more than 220 per cent in 2013. Assets in the formal and shadow banking sector increased from around $10tn to as much as $25tn. That means China created new credit roughly equivalent to the entire US banking system in the space of five years. The massive stimulus quickly led to a rebound in growth rates, but the new credit soon began weighing on lenders’ balance sheets and capital requirements. So, with tacit

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approval from policy makers in Beijing, alternative forms of credit began to sprout in the shadows. The banks repackaged their riskiest loans to their least creditworthy borrowers, including many LGFVs, and sold them as “wealth management products” to ordinary depositors. Lightly regulated trust companies joined the action, making high-interest loans to risky borrowers, repackaging them and selling them through banks as “trust products”. On paper, trust products are only supposed to be sold to investors with Rmb1m to spend but this rule is often broken. And the trusts were designed to be alluring. Deposit rates in China are capped by the government but these innovative trusts were classified as investment products, allowing banks to tempt depositors with the promise of much higher returns. “The non-bank side of the financial system is primed for disaster and nowhere more so than in the trust sector,” says Jonathan Anderson, founder of Emerging Advisors Group. “Trust products are genetically engineered to go bad when the credit taps turn off.” Growing fast After the Chinese economy rebounded in 2009 and 2010, policy makers began worrying about wasteful investment and asset inflation. Banks were told to cut back on lending to real estate projects, local government borrowers like Yuncheng City Investment and industries suffering from serious overcapacity, such as steel, glass and cement. That created enormous demand for the high-interest loans on offer through the fledgling shadow banking sector. FT Series: Into the shadows// Next in the series: how shadow banking is restructuring the financial landscape and Paul McCulley on challenges for the US Federal Reserve Economists at Barclays estimate the size of China’s shadow banking system at around Rmb38.8tn at the end of last year, or around a quarter of the size of total assets in the banking sector. Analysts say roughly half of all credit extended in 2013 came from outside the formal banking system. Part of this includes activity such as corporate bond sales that would not be considered shadow banking in other economies. But much of it is made up by the wealth management and trust products that Chinese regulators are worried about. Total outstanding trust product assets in China rose 8 per cent in the first quarter from the previous quarter to reach Rmb11.7tn, a fourfold increase from the total at the end of 2010. As much as Rmb5.3tn of those products will come due this year, according to estimates from Haitong Securities, a Chinese brokerage. Biting the bullet Yuncheng City Investment was established in 2003, earlier than most of its peers, as a way for the local government to access bank loans to pay for public works. But the company was mostly dormant until 2009, when the local government gave it a staff of several dozen people and launched it into a frenzy of borrowing and investing in roads, museums and government-subsidised housing.

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When policy makers in Beijing turned off the credit flowing from state banks to LGFVs, City Investment turned to the corporate bond market, raising Rmb800m from a 2012 bond sale to investors for which it had to pay 7.5 per cent annual interest. But last year Mr Qiao and his colleagues were told they would not be allowed to tap the bond market again thanks to new rules linking government officials’ performance to local debt levels. So, despite the almost 10 per cent interest rate they would have to pay, they decided to launch a trust product and turned to Sino-Australian International Trust, a Shanghai-based venture between two state owned companies and Australia’s Macquarie Bank, which owns 20 per cent.

The two-year trust product Mr Qiao is trying to sell – he had planned to raise Rmb350m by the end of March – was collateralised by a piece of land near the Yuncheng airport. The fortunes of the property developments he can see out his window are of great importance to Mr Qiao since government land sales to commercial real estate developers provided almost two-thirds of Yuncheng’s Rmb22.4bn in fiscal revenue in 2012. City Investment’s outstanding debt before it launched its trust product was already Rmb4.2bn, or almost half of the Rmb9.1bn in revenue Yuncheng City took in last year from sources other than land sales. Unfortunately for Mr Qiao, Yuncheng’s real estate market has hit a rough patch. “Prices are falling and sales are really terrible because too many apartments have been built and so many of them are empty,” said a sales manager at a property development on the outskirts of Yuncheng who would only give his surname, Guo. Mr Guo says in the district where he works the government approved 800,000 square metres of new property construction last year alone, even though the total population of the district is just 300,000 and most people cannot afford the apartments. The term sheet for City Investment’s trust product is not very long or detailed. But it points out that Yuncheng has several large industrial companies that the local government can rely on for tax revenues. Too many apartments have been built and so many of them are empty - Property development sales manager

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The first company on that list is Highsee Iron and Steel Group, which recently collapsed under the weight of more than Rmb20bn in debt. A large aluminium smelter that is another important source of the city’s tax revenues is facing such dire market conditions that it loses as much as Rmb30,000 on every ton of metal it produces, according to local officials. They say the company has responded by shutting down production. The bailouts begin Even as China’s economy is slowing and revenues from land sales dry up, local governments such as Yuncheng’s are being called on to prop up their financing vehicles and bail out the high-interest trust products they have sold to investors. At best, this could push growth lower, since government revenues will be diverted from new investment into paying off old debts. At worst, collapsing government revenue will lead to financial crises as defaults in the shadow banking sector soar and investment- reliant growth collapses. Yuncheng is not a particularly extreme example, since Mr Qiao and his colleagues have been relatively conservative in their borrowing. Many Chinese cities have dozens of LGFVs that have issued scores of trust products between them. “Yuncheng represents a case of a city in real need of financial restructuring and there are many cities like this across China,” says Li Daokui, of the Center for China in the World Economy at Tsinghua University and a former member of the central bank’s monetary policy committee. “The central government will have to step in to facilitate this restructuring but the holders of these kinds of high-interest trust products across the country will definitely lose money.” As far as the banks and trust companies such as Sino-Australian are concerned, any risks of default by borrowers like City Investment are borne by investors alone. Most ordinary investors bought the wealth management and trust products assuming they were guaranteed by the government, since they were usually sold by state banks. But many investors are starting to question this assumption. Some are even taking to the streets to protest and demand the government bails them out. That is bad news for Mr Qiao and his trust product. But it is also a concern for financial regulators in Beijing, who would like to limit the growth of shadow banking but who realise the sector has become so big that it now has the potential to destabilise the entire system. “Right now there is a lot of concern over the fiscal condition of the system,” a senior financial regulator said. “If we see a very sudden withdrawal of funds from the shadow banking system then it will definitely be a macroeconomic problem.” http://www.ft.com/intl/cms/s/2/a123375a-d774-11e3-a47c- 00144feabdc0.html#axzz34z7X5JC1

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Daily Morning Newsbriefing June 16, 2014 On the side effects of June 5 There was quite a bit of discussion over the weekend about the long-term effects of the ECB’s decisions on June 5. While the effects on the eurozone are minimal, there are two areas where the effects are likely to be stronger: funding policies of emerging markets, and bank profits. Reuters has done some number crunching on emerging market bond issuance, and found that the ECB’s policies have led to a boom of euro-denominated debt. So far this year, EM government and firms have borrowed over €41bn, more than during the whole of 2013, according to Reuters. The reason is, for one, the bund-treasury spread, of about 1.3pp. What makes the euro issuance particularly attractive is the historically cheap cross-currency basis swaps, which makes it cheap for countries to raise funds in euro if we their outgoing payment stream is in dollar. Among the countries mentioned in the Reuters story are South Korea, which has tapped the euro market for the first time ever, Abu Dhabi’s telecoms operator Etisalat, and most recently Morocco, which offered to pay 225bp over mid-swaps for 10-year debt, which equates to a yield of 3.8%. It seems low the article said, but Morocco’s credit rating is only a notch below that of Spain, where 10-year yields are 2.6% at the moment. The International Financial Review has a story according to which TLTRO will boost bank profits more than the economy. Citing a JP Morgan, according to which just 5% of the outgoing LTRO went to the real economy, it appears that the TLRTO might go the same way, inducing banks to borrow cheap and bid up at 0.25% for four years to buy government and corporate bonds – an almost riskless profit. Under the TLTRO, banks can borrow up to 7% of the loans to businesses and companies (excluding mortgages). With €5.7tr of eligible assets, that would cap the TLTRO at €400bn. The article quoted one analyst as saying that it would be wrong for the ECB to think that it has control on how these funds will be used, as asset and liability side of a balance are completely separate. David Folkerts-Landau of Deutsche Bank writes in Frankfurter Allgemeine that the policies will fail to address the three biggest dangers: low inflation, weak credit growth and a strong euro. He also makes the point that the TLTRO is not truly targeted. There is no conditionality on how banks use the money. The low financing costs will only benefit borrowers if banks consider the i/r margins as sufficient. That is not yet the case. And third, the eurozone is in a balance sheet recession, with demand for credit likely to remain weak. He said that the effect on German and French growth will be a negligible 0.02pp and 0.07pp respecitively. We also noted a comment from Benoit Coeure, as quoted by Reuters. While we do not usually care about the speeches given by European central bankers, as they often add more noise, we were struck by his statement to journalists that QE was “not needed now, because we do not see deflation in the euro zone”. While he then kept to repeating 245

the ECB’s official line, what surprised us is the assumption that QE is something you do when you “see deflation” – whatever that means. Alexander Stubb to be Finland’s next prime minister Alexander Stubb won the leadership of his ruling Conservative party on Saturday, putting him on track to become prime minister later this month. Katainen's cabinet will resign today, according to WSJ, and a new cabinet is expected to be formed by the end of June based on the current five-party coalition government with Stubb as its head. He will face the immediate task of holding Finland's fractious coalition government together until the general elections in April 2015. Policy platform negotiations between the coalition parties will take place next week. Reuters writes that Stubb wants to cut taxes and take his neutral country into NATO. In a news conference directly after the vote Stubb says “I support cutting taxes. I am certain we can end falling further into debt in the coming years.” When constitutional courts interfere Maria Luís Albuquerque, Portugal's finance minister, tells the FT that the constitutional court’s frequent interventions have raised questions over potential clashes between national constitutions and eurozone policy making. Some see the row between the government and the court as an example of how international rescue programmes can pose a threat to national sovereignty and the democratic process. Others believe that constitutional courts in Portugal, Spain, Germany and elsewhere need to take account of the implications of their rulings for the broader stability of the eurozone. In Portugal, the court’s mission is to ensure that legislation does not violate the rights of citizens enshrined in the 1976 constitution. Ten of the court’s judges are nominated by parliament and three by the other judges. Although the appointments tend to reflect the balance of party political power, the judges rarely vote along party lines. But to the annoyance of critics, including the prime minister and some EU policy makers, neither do they appear to take international financial commitments into account. A paper on the missing Greek export puzzle We picked up this European Commission economic paper on why is Greece such a surprisingly low exports, a debate we followed over the last couple of months. The authors use a gravity model and find that weak institutional quality accounts for a large part of this shortfall. Using a rich dataset of bilateral value-added exports of goods and services of 39 exporters and 56 importers for 18 sectors, they first estimate that Greece exports at one third less than what would be expected from regular international trade patterns. They then augment the model with various measures of institutional quality and find that weak institutions can explain much of the missing Greek exports puzzle. Improving the Greek institutional framework to the EU/OECD average level would close between half and three quarters of the Greek export gap, they conclude. Comment: While it gives us some numbers to juggle with, it does not address Daniel Gros’ more subtle argument that whatever reform agenda Greece adopts on paper what counts is what is implemented on the ground. According to Gros it is the way the Greek economy responds that determines on how successful the reforms will be. The institutional indicators included hardly capture that gap.

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Greek coalition partners at odds over dismissal targets Pasok openly questioned the government’s targets for firing civil servants this year, suggesting that a better method for evaluating their performance should be created before more public sector workers lose their jobs, Kathimerini reports. The government has pledged to sack another 7000 civil servants this year to meet the target it has agreed with the troika. However, a dispute has broken out between Pasok and New Democracy officials about how this should be achieved. Administrative Reform Minister Kyriakos Mitsotakis and Education Minister Andreas Loverdos disagreed over how many university administrative employees should be rehired after being placed in a labour reserve last year, with the remainder being dismissed. Loverdos calls for 880 out of the 1134 university employees to be rehired while Mitsotakis insists that there can only be 500 otherwise others need to be fired to fulfil the target. Polarisation of the French left The left in France is about to split into two opposing strands dictated by the fear of the Front National rising further, writes Cecile Cornudet in Les Echos. It is no longer a fight of arguments but that between two ideologies. There is one 'reformist' fraction, assuming the public needs to see reform results. And there is a 'relaunch' fraction, who believe only with a demand shock will France find its way out. Over the weekend 'rebel' Socialists who believe in the latter united the communists and the ecologists to define an "alternative majority." The question is how many will convert amid an already tight majority in parliament. The SNCF rail strike, meanwhile, continues into its sixth day. Grillo offers co-operation on electoral reforms The main Italian news story over the weekend is the offer by Beppe Grillo to talk to Matteo Renzi over a co-operation electoral reforms. Corriere della Sera writes that Renzi smells a rat. Renzi knows that these are not peace talks at all. Renzi’s own analysis of the situation, as retold by Corriere, is that Grillo has got himself into a hole over his decision to ally himself with Nigel Farage, a decision that is controversial among members of the Five Star Movement. But Renzi also suspects that Grillo was to re-introduce the proportional representation and transferable votes – the danger being that this could also be acceptable to a minority in the PD itself Where now for the AfD? Noah Barkin and Stephen Brown of Reuters have a thoughtful analysis of the political options of the AfD in Germany, which aligned itself to the Tories in the EP. There are three state elections in August and September – Saxony, Thuringia and Brandenburg. The alignment with the Tories should help the party gain more respectability, which the party is intending to use in its advertising campaign. Another issue is whether any of the regional CDUs would co-operate with the AfD, or form a coalition. Merkel has said No, but if the CDU falls short of a majority in any one of those states, the AfD may be the only coalition partner to form a stable governments, other than a grand coalition. The article makes one very good point – that the CDU could face years of infighting to define its relationship with the AfD, and this might cripple the party just as a debate about the Left

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IMF board discusses re-profiling The FT has the story that the IMF’s executive board has discussed a paper that sets out alternative bailout strategies. The article says the proposal includes the options that private creditors agree to a reprofiling of existing bonds with maturity extensions for the duration of the IMF programme. The article said a model was the voluntary debt exchange as part of the fund’s programme in Uruguay in 2003.” The proposal was discussed on Friday, but there were disagreements about the “systemic exemption” that allowed the IMF to short-cut its sustainability analysis if there are fears of a systemic crisis. The argument is that the systemic exemption is unfair because it benefits only countries deemed to be systemic. Credit Crunch vs low demand Frankfurter Allgemeine, which reports news from Italy in a detail unsurpassed anywhere outside Italy, has a terrific report on the latest monthly report of the Bank of Italy, which has some shocking data on the state of the Italian loan market. One third of Italian small companies, about 1.5m, are in financial difficulties without any further financial help. The accumulated fall in GDP of 9% since 2008, has hurt many companies. The banks’ accumulated losses from credits to the private sector were €130bn, which in 2012 and 2013 had eaten up all the profits. 31% of all corporate credits are in trouble. The Bank of Italy does not side with the view that the banks had been irresponsible, according to FAZ. The problem is with the companies. They are too nationally focused, too indebted, and over-reliant on short-term credit. Wolfgang Munchau makes a similar point in his FT column when he says that the eurozone’s current situation is many respects similar to how Atif Mian and Amir Sufi describe the situation in their House of Debt – only worse because the eurozone is only now starting to clean up their bank balance sheets – an obvious parallel to what happened in Japan. The analysis would suggest that the eurozone is looking at a long period over very low growth and inflation. He also makes the point that investors are currently misjudging the contribution that they will have to make in the debt reduction process. Note also the critical comments from “Mussa” – one of the most insightful regular commentators – who points out that the situation does not apply to Italy where the credit crunch is the clear problem. Eurozone Financial Data 10y spreads

Previous This Yesterday day Morning France 0.371 0.370 0.368 Italy 1.448 1.420 1.428 Spain 1.323 1.298 1.299 Portugal 1.986 2.027 2.052 Greece 4.370 4.450 4.47 Ireland 1.037 1.042 1.039 Belgium 0.487 0.490 0.489 Bund Yield 1.386 1.367 1.359 exchange rates

Previous This

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morning Dollar 1.354 1.3534

Yen 138.110 137.81

Pound 0.798 0.7966

Swiss Franc 1.217 1.2176

ZC Inflation Swaps previous last close

1 yr 0.8 0.8

2 yr 0.89 0.89

5 yr 1.25 1.25

10 yr 1.66 1.66

Eonia

13-Jun-14 0.03

12-Jun-14 0.04

11-Jun-14 0.06

10-Jun-14 0.07

OIS yield curve

1W 0.035 15M 0.026 2W 0.035 18M 0.032 3W 0.035 21M 0.058 1M 0.040 2Y 0.062 2M 0.042 3Y 0.128 3M 0.041 4Y 0.252 4M 0.039 5Y 0.409 5M 0.039 6Y 0.589 6M 0.036 7Y 0.772 7M 0.034 8Y 0.949 8M 0.032 9Y 1.109 9M 0.031 10Y 1.254 10M 0.035 15Y 1.775 11M 0.030 20Y 2.000 1Y 0.030 30Y 2.092

Euribor-OIS Spread previous last close

1 Week 3.500 3.5

1 Month 9.057 7.957

3 Months 16.571 15.771

1 Year 41.114 42.314

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-06- 16.html?cHash=7027bef1e25ab7f380859a19f6603d00 249

ft.com comment Columnists June 15, 2014 5:38 pm Europe faces the horrors of its own house of debt

By Wolfgang Münchau The most likely trajectory is a long period of slow growth, low inflation One of the more important insights about the state of the European economy right now comes from postcode data in the US. In their magnificent book House of Debt, Atif Mian and Amir Sufi find that what is outwardly disguised as a credit crunch is in reality a fall in demand for loans. Their analysis lends credence to the idea of a balance sheet recession: the notion that indebted households and corporations do not care about cheap interest rates but just want to offload debt. When that happens, monetary policy becomes ineffective. Richard Koo of the Nomura Research Institute saw exactly the same phenomenon in Japan 20 years ago. It is still the best explanation of what happened there. Mr Mian and Mr Sufi seek to provide a partial answer to this question: why has US growth been so weak even after the clean-up of the banking system? In Europe the situation is similar, only worse. It has not even done the clean-up. It has taken the eurozone six years after the collapse of Lehman Brothers to start what the European Central Bank euphemistically calls the “comprehensive assessment”. We will not know the results until the fourth quarter. The stress tests of 2010 and 2011 were discredited because they failed to flag the dangers ahead. I expect a slick presentation this time – a triumph by PowerPoint. What we know so far is not good. For example, the “adverse scenario” is more optimistic than the ECB’s own inflation forecast. They have taken the stress out of stress test. More ON THIS STORY// Carney boosts ECB fight against deflation/ Portugal turns down €2.6bn rescue payment/ Europe inflation-linked debt sales fly/ Draghi in battle to head off deflation/ ECB goes below zero to thaw economy ON THIS TOPIC// Fast FT Cyprus preps for full bond market return/ Sliced and diced debt deals make comeback/ Global Insight Time for ECB to act, but talk needed too/ Italy’s borrowing costs at euro-era low WOLFGANG MÜNCHAU// Europe’s drifters wait/ Italian rescue/ Change inflation tactics/ Draghi’s missed chance on inflation But according to Mr Mian and Mr Sufi, none of this may matter as much as we think. Moritz Kraemer of Standard & Poor’s came up with corroborating evidence last week, when he did the maths on private sector debt in Europe. His analysis reads like a European version of House of Debt – only more scary. Mr Mian and Mr Sufi at least described the past; Mr Kraemer explains the future. The Europeans have barely begun to deleverage. In Spain and Ireland the process has at least started. But it will take years, maybe decades, until it is completed.

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Take Portugal, which is about to exit its support programme from the European Stability Mechanism and the International Monetary Fund. Its private sector debt reached a peak of 226.7 per cent of gross domestic product in 2009. It was still 220.4 per cent at the end of 2013. S&P has run a simulation under which Portugal’s private debt could fall to 178 per cent of GDP by 2020. That is still a big number. But it may be too optimistic. Portugal and other peripheral eurozone countries will need to deleverage and simultaneously deflate their prices to become more competitive. What makes it even harder is that inflation in the eurozone has been falling. Low inflation raises the real value of future debt, and reduces the ability to cut prices. Is it feasible? Today’s market consensus says yes: the eurozone crisis is over. Yes, there was some upheaval at last month’s European parliament elections, but we will muddle through politically. Surveys tell us that European businesses are becoming optimistic. Investors are exuberant. I am often hearing how great the mood in Spain seems to be. All’s well that ends well. The implication of House of Debt and the S&P study is that the conventional market view of the post-crisis environment is dead wrong. The most likely trajectory is a long period of slow growth, low inflation, and a constant threat of insolvency and political insurrection. If the private sector were to reduce debt in such an environment, certainly on the scale as suggested by S&P, it would be a lot harder and possibly bloodier than any of the adjustment we have seen so far. When the Japanese private sector began to deleverage in the early 1990s, the government increased its debt to absorb the shock. The Europeans did the same to some extent during the crisis as well. Spain, for example, was able to maintain large deficits. But from 2016, the strictures of the eurozone’s fiscal compact will kick in and force an acceleration in fiscal consolidation. The new fiscal rules will amplify the effects of private sector deleveraging. The bottom line is that the total post-crisis adjustment will be much more brutal than it was in Japan 20 years ago. In such an environment I would expect the political backlash to get more serious. More people in more countries will question the benefits of the EU and the euro in particular. Even if deleveraging could work economically – which is not clear – it may not work politically. My guess is that if the Europeans had to choose between deleveraging and default, they will pretend to do the former and end up with the latter. By reducing political instability, they will end up increasing financial instability. I am just not sure that investors understand the risks. Nor do they seem to understand the implications of recent EU legislation establishing a new pecking order of who pays how much and in what order when a bank fails. When the house of debt collapses, it is they, not the taxpayers, who come first. http://www.ft.com/intl/cms/s/0/beef494e-f255-11e3-9e59- 00144feabdc0.html#axzz34p9hUT9q

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ft.com/markets MARKETS INSIGHT June 16, 2014 6:03 am Time to take some chips off the table By Mohamed El-Erian Revival of ‘goldilocks’ story encourages levering risk exposures Investors have rekindled their romance with the “Great Moderation”, and fallen back in love with “goldilocks”. These two terms are among the most powerful in the markets lexicon. They encourage many investors to stretch and stretch again for extra returns by levering exposures to a broad range of risk factors. Yet what appears both a reasonable and rational strategy at the individual level, given current conditions, threatens a disruptive fallacy of composition at the macro level down the road. More ON THIS TOPIC// On Wall Street Equity bulls rest case on low inflation/ The Short View US Treasury bonds look appetising/ Gavyn Davies Can Great Recession be repaired?/ Wall Street ‘fear gauge’ hits 7-year low MARKETS INSIGHT// Grouchy EU bonds tell downbeat story/ Crazy equities should be boring as bonds/ Echoes of pre-crisis world grow/ Corporate tax escape trick set to backfire The terms last featured prominently in 2005-07 when the belief spread that policy makers had succeeded in overcoming the business cycle, thus leading to low economic and market volatility – at least for a while. The result was excessive and irresponsible risk-taking. Their recent reappearance, while less dramatic, is due to two factors: an economy that is improving slowly but in a rangebound fashion, with little prospect of either a collapse or lift off; and a Federal Reserve that is transparent, measured and supportive of asset markets. Investors have taken these two factors as signalling a predictable and extended period of economic, financial and policy calm. And should this calm be threatened by some unanticipated development, such as a geopolitical shock, they have been conditioned repeatedly to expect the Fed to step in and restore it quite promptly. Risk exposure This environment is one that naturally encourages investors to use borrowed money to increase their exposure to risk factors, particularly in the more liquid public markets. In the process, they continuously compress the risk premiums and, therefore, the reward for taking ever greater exposure. Yet, with the promise of more tranquillity ahead, they will “ride the market” until there is an unambiguous signal of a “turn”. This phenomenon is amplified by a few rigidities. Investors are loath to reduce their return expectations even though initial investment valuations have moved significantly higher. The cost of applying the brakes too soon is increased by capital allocators who can be sensitive to short-term performance.

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Meanwhile, many investors are comforted when they are part of a herd, even if it is one that ends up going to excess. And few investment banks are willing to take large positions on the other side given that shareholders seem to have less patience for shortfalls in trading revenue, no matter how short term. The behaviour of most financial investors stands in contrast to that of companies and some central bankers. Many companies are still hesitant to invest in plants and equipment notwithstanding cash on their balance sheets and low-cost borrowing opportunities. They know they do not have their financial counterparts’ ability to unwind their risk exposures and thus engage only tentatively in substantial long-term commitments. Market instability For its part, the Fed is comforted by continued signs of labour market slack, including in this month’s jobs report. Yet more central bankers (including US regional Fed presidents Narayana Kocherlakota and Eric Ronsengren, and former Fed governor Jeremy Stein)are recognising that current Fed policy may result in “signs of financial market instability”. With a rather anaemic economy, the central bank is willing to trade higher financial instability down the road for greater economic healing in the present; and it believes (or more accurately hopes) that the recent strengthening in macroprudential regulation will prove sufficient to limit such financial instability should it materialise. All this suggests that, rather than continuously increasing exposure to ever rising markets, it is time for highly exposed investors to gradually take some chips off the table. They also need to monitor the liquidity of portfolios carefully, as it makes less and less sense to give up their flexibility to reposition for what is a low reward for assuming large liquidity risks. And, in taking long positions in markets, they should guard against falling hostage to a “relative” valuation mindset that overwhelms any assessments of the overall compensation for risk. In their efforts to promote growth and jobs, central banks are trading the possibility of immediate economic gains for a growing risk of financial instability later. This does not necessarily mean investors should rush for the exits, immediately and in size. But it does call for the type of incremental prudence that today’s marketplace appears overly hesitant to adopt given the recent evolution of market prices. Mohamed El-Erian is chief economic adviser to Allianz, chair of President Barack Obama’s Global Development Council, and author of “When Markets Collide” http://www.ft.com/intl/cms/s/0/3b4671aa-efec-11e3-a943- 00144feabdc0.html#axzz34p9hUT9q

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ft.com/global economy June 15, 2014 9:30 pm IMF discusses third way over bailouts By Robin Harding in Washington

©Bloomberg The International Monetary Fund is discussing changes to its rules that could require countries in difficulty to extend maturities on their sovereign debt as a condition of seeking its help. At present, the IMF’s options are limited to a pure bailout or upfront debt restructuring based on whether the fund considers the country’s debt to be sustainable. The mooted idea offers a third way by allowing creditors to agree instead to a “reprofiling” of existing bonds. Maturities would be extended for the duration of the IMF programme with no change to the coupon or principal. More ON THIS STORY/ ‘The Summit’, by Ed Conway/ IMF sounds housing alarm/ Emerging nations eye IMF leadership post/ Zambia in plea to IMF after currency dip/ IMF endorses UK deficit reduction plan ON THIS TOPIC// IMF warns ‘rising’ Africa on debt risks/ Fast FT IMF chief lambasts banks' fightback on reforms/ Arab uprising economies begin to improve/ Martin Wolf Equal society will not hinder growth IN GLOBAL ECONOMY// EU-US trade talks hit roadblock on banks/ US manufacturing, India inflation/ Fed ponders fresh cut to growth forecasts/ UK behind Germany and France, says China The ideas are being discussed as the fund seeks to learn the lessons from its approach to sovereign debt restructuring in the wake of the troubled Greek rescue in 2010. Last Friday, its executive board discussed a new paper, according to bankers consulted in the process and people close to the board. It raises the prospect of big changes to how private bondholders are treated under big IMF programmes, after a difficult period that has shaken the balance of power between governments and their creditors. People involved in the discussion said the work was still preliminary, there were differences of opinion on the executive board, and no conclusion was likely before the end of the year. The IMF declined to comment. At present, the IMF’s policy says there must be a high probability that a country’s debt is sustainable for the fund to provide a large loan under its “exceptional access” criteria. That means it has two choices: provide the loan, with no hit to private creditors; or insist on a painful, upfront restructuring.

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In the case of Greece, the eurozone institutions and the IMF were unwilling to enforce losses on private creditors upfront – partly because of fears of contagion to other eurozone countries – only for a restructuring to prove necessary in 2012. The new alternative would apply only in situations where there was genuine doubt about debt sustainability. It would ask private creditors to agree to a freeze as a condition of the IMF programme. A model is the voluntary debt exchange as part of the fund’s programme in Uruguay in 2003. The fund has been consulting markets to make sure that any change does not cause investors to avoid sovereign debt and raise borrowing costs. Those consultations are likely to continue for the rest of the year. According to people present, the paper was well received by the IMF executive board – which represents the member countries – but there was significant debate about the need to keep a “systemic exemption”. That allows the IMF to short-cut its sustainability analysis if there are fears that failure to lend could lead to a systemic crisis, as was the case in the eurozone. Many countries would like to get rid of the systemic exemption. They regard it as unfair, since it helps only systemic countries, and dislike the loophole it creates – since almost anything can be made to seem systemic. Some also believe it does not help, since IMF lending does not end crises if a country’s debt is still unsustainable. Others think it is necessary to keep the option to lend freely in a crisis. http://www.ft.com/intl/cms/s/0/713abdb8-f4a9-11e3-bf6e- 00144feabdc0.html#axzz34p9hUT9q

Argentina debt crisis fears grow after US supreme court ruling Share prices fall 6% as US court refuses appeal against decision in favour of creditors who bought up debt worth $1.3bn Larry Elliott, economics editor The Guardian, Monday 16 June 2014 18.20 BST Fears of a fresh debt crisis in Argentina intensified after a ruling by the US supreme court left South America's second biggest economy facing the choice of paying so- called "vulture funds" in full or risk a fresh debt default.

Share prices fell by 6% at the start of trading in Buenos Aires and the price of Argentinian bonds fell after America's highest court refused to hear an appeal against a ruling by a lower court that came down in favour of creditors who bought up debt worth $1.3bn (£770m) at rock-bottom prices after the financial crisis of more than a decade ago.

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The ruling is the culmination of a decade-long legal battle in which Argentina has sought to avoid paying creditors who refused to accept the terms of a debt restructuring that followed the country's savage financial crisis of 2001-2. In an attempt to make the country's debt more manageable, the then government in Buenos Aires offered bondholders a deal in which they would get regular payments of interest provided they accepted a more than 70% reduction in the value of their investment. More than 92% of creditors agreed to the offer – in many cases reluctantly – but a number of hedge funds, spearheaded by Paul Singer's NML corporation held out. Argentina argued that the funds bought most of the debt at a deep discount after the default and have sought to thwart the country's efforts to restructure in two separate debt swaps in 2005 and 2010. The country, which grew rapidly after it devalued the peso and defaulted on around $100bn of debt in 2002 but has since suffered from uncomfortably high levels of inflation, is now under pressure to come to terms with the hedge funds before the next scheduled payments on the restructured debt at the end of the month. If it refuses or fails to do so, it would technically be in default. Argentina's president, Cristina Fernández de Kirchner, was due to make a televised address in response to the US ruling early on Tuesday, but has until now adopted a hardline approach in the legal battle, warning that it was unable to pay meet both the demands of the hedge funds and its regular interest payments. The filing to the supreme court said that if forced to pay: "Argentina will have to face, objectively, a serious and imminent risk of default." The bondholders disputed that claim, saying in their own court filing there was evidence presented in lower courts that Argentina could afford to pay. However, the prospect that Buenos Aires might defy the supreme court unsettled bond markets and sent the cost of insuring Argentina against default soaring. The "upfront cost" of a five-year credit default swap surged from 36% to 46% – meaning it would cost almost half the face value of a bond to insure it each year. In a second setback for Kirchner, the supreme court also ordered that commercial banks be forced to provide details of assets held by Argentina around the world. Argentina has been contesting an August 2013 ruling by the 2nd US circuit court of appeals in New York, which upheld a November 2012 ruling by US district judge Thomas Griesa. He ordered Argentina to pay the $1.33bn into a court-controlled escrow account. Debt campaigners expressed concern at the refusal of the supreme court to overturn the findings of the lower courts. Eric LeCompte, executive director of the religious anti-poverty organisation Jubilee USA, said: "I am blown away by the decision. For heavily indebted countries trying to support extremely poor people, this is a devastating blow. These hedge funds are equipped with an instrument that forces struggling economies into submission. "For 15 years, Republicans and Democrats have agreed that the world's poorest countries need to have their debt burdens reduced. Today, that bipartisan policy is threatened by the court's decision." http://www.theguardian.com/world/2014/jun/16/argentina-debt-crisis-fears-us-supreme- court-ruling/print 256

POLITIQUE Valls et sa gauche : l’incompréhension CECILE CORNUDET / EDITORIALISTE |LE 15/06 A 18:42, MIS A JOUR LE 16/06 A 09:54| Lu 4448 fois

Cécile Cornudet, éditorialiste aux Echos - Crayonné Fabien Clairefond pour Les Echos Le Premier ministre dramatise l’enjeu – « La gauche peut mourir », dit-il –, mais le fossé se creuse avec le PC, les Verts et une partie du PS. Le front social se durcit, le bras de fer politique ne faiblit pas pour autant. Deux mois après la nomination de Manuel Valls à Matignon, la menace majoritaire reste entière sur les textes devant donner corps au pacte de responsabilité. Ces dernières semaines, le Premier ministre s’est démené comme jamais pour recevoir les parlementaires de gauche, les écouter et mettre l’accent sur le pouvoir d’achat. « Il s’est plus occupé de sa majorité que du gouvernement », note même un ministre. Rien n’y a fait. Le ton monte et le fossé se creuse. L’exécutif et une partie de sa gauche en sont arrivés à ce moment des couples en crise où tout ce que dit l’un est interprété contre lui, où toute main tendue est suspectée d’être insincère. « La gauche peut mourir… Le risque de voir Marine Le Pen au second tour de la présidentielle existe »,a lancé samedi Manuel Valls devant le PS, l’appelant à faire bloc. Propos mobilisateurs ? Non ! propos vécus comme provocateurs. « C’est une manœuvre, des propos assez irresponsables, alors que le vrai problème est qu’il ne conduit pas une politique de gauche », a affirmé Pierre Laurent (PCF) sur France 3 hier ; « Pour faire vivre la gauche, il faut une politique de gauche », a jugé Emmanuelle Cosse, à la tête des écologistes, de plus en plus radicaux. Le risque Le Pen existe, affirment-ils tous deux, mais c’est justement pour cela qu’il faut réorienter l’action à gauche. Après le conseil national du PS, samedi soir, des frondeurs du PS avaient réuni des communistes et des écologistes pour définir une « majorité alternative ». Le PS réplique en proposant – sans beaucoup de succès – un « programme minimum » à la gauche. Derrière ces opérations, il y a deux lignes qui s’affrontent, opposées, et de fait dictées par la peur du Front national. Une politique « réformiste » pour le gouvernement qui pense que les Français veulent des « résultats » ; une politique de relance, pour sa gauche. « Prendre un autre chemin conduirait à l’échec », dit Manuel Valls. « Ce chemin nous mène dans le mur », lui répond-on. On n’est plus dans la bataille d’arguments mais dans la guerre de religion. Avec une question à la clef : combien d’âmes converties, dans une majorité déjà bien étroite ? C’est l’enjeu des prochains votes. http://www.lesechos.fr/politique-societe/politique/0203566605785-valls-et-sa-gauche- lincomprehension-1012965.php

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The Wall Street Journal World News ECB's Coeuré Says Quantitative Easing Not Needed at Present Executive Board Member Says Recent Moves Are Growth Friendly By Brian Blackstone Updated June 13, 2014 1:21 p.m. ET DUBROVNIK, Croatia—The European Central Bank has the option of engaging in large-scale asset purchases, known as quantitative easing, but such a policy is not needed at present after the bank unveiled extraordinary measures to fight too-low inflation last week, a top ECB official said Friday. "It's in the toolbox. It's not needed now, let me be very clear. It's not needed now because we don't see deflation in the euro zone and we have a deep sense that the measures we decided last week are appropriate to face the prospects of low inflation," ECB executive board member Benoit Coeure told reporters during a conference held by Croatia's central bank. On June 5, the ECB installed a negative rate on bank deposits parked overnight at the central bank. Though the reduction to -0.1% from zero in this rate was small, it was symbolically important by making the ECB the largest central bank to try such a policy, which effectively penalizes banks for depositing surplus funds with the central bank rather than lending them to other financial institutions. Its main lending rate was reduced to 0.15%, a record low, from 0.25%. In addition, the ECB said it would make cheap bank loans available at four-year maturities starting in September on the condition that banks in turn boost their own lending to the private sector. That is the longest maturity the ECB has ever offered for loans. The ECB also said it would accelerate plans to purchase asset-backed securities. Central Bank Watch Here is how the central banks in four major advanced economies have moved two key levers of monetary policy in recent years, and how two important economic indicators have responded. View the interactive. And ECB President Mario Draghi put markets on notice after the decision that more action could come later. "Are we finished? The answer is no, we aren't finished here. If need be, within our mandate, we aren't finished here," he said after the ECB's June 5 meeting. But the ECB stopped short of quantitative easing, a policy used extensively by central banks in the U.S., U.K. and Japan to keep long-term borrowing costs low and boost growth and inflation. These economies have seen more vigorous recoveries in recent 258

quarters than the euro zone has, and annual inflation in the U.S., U.K. and Japan is closer to the 2% level that large central banks consider optimal for their economies. Unlike the central banks in these countries, the ECB sets policy for 18 vastly different economies from Germany to Greece. Struggling euro members with high unemployment have very low inflation, and some have outright price declines. The ECB's rate cuts and other steps last week came days after a report showing annual euro zone inflation weakened to 0.5% in May. Some private sector economists expect it to soften even more this summer. Quantitative easing is "in the toolbox in case the situation will change later on. But we don't expect that situation to materialize because we believe what we decided last week was appropriate," Mr. Coeure said. Instead, the ECB's focus is on assessing the effects of its interest-rate cuts and implementing its new targeted bank-lending program, which starts in September. The measure of success, he said, is whether inflation grinds higher toward the ECB's 2% target. The ECB's actions have created a better environment for economic growth, Mr. Coeure said earlier Friday, but he warned that the euro zone's long-run prospects depend on productivity enhancements, something the ECB has little control over. His comments echoed those of other ECB officials in recent days, suggesting that the ECB wants time to gauge the effects of its actions and that additional stimulus is unlikely for the next few months. Engaging in large purchases of public and private debt is challenging in the euro zone, which has 18 separate national bond markets. The market for bundled bank loans in Europe is much smaller than it is in the U.S., giving the ECB fewer private-sector securities to buy. Purchasing government debt is highly controversial in Germany, where it stirs concerns of inflation and a loss of central-bank independence. Speaking at the same conference in Croatia on Thursday, Germany's central bank president Jens Weidmann underscored his fierce opposition to central-bank purchases of government bonds, an indication that while he approved last week's measures, he would likely oppose quantitative easing. Purchases of government bonds "bring monetary policy very close to monetary financing of governments, which could undermine the central bank's ability to maintain its mandate of price stability," Mr. Weidmann said, calling the policy "sweet poison" for governments. Write to Brian Blackstone at [email protected] http://online.wsj.com/articles/ecbs-coeure-says-stimulus-measures-are-growth-friendly- 1402666845#printMode

Economía Los cursos de formación en España nacho catalán Madrid13 JUN 2014 - 21:15 CET17

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Fuente: elaboración propia a partir de presupuestos de SEPE 2013 y normativa de Formación para el Empleo// http://elpais.com/elpais/2014/06/13/media/1402686906_371942.html 260

La gran estafa española La corrupción ha marcado la historia de los cursos de formación, un sistema de miles de millones que en muchos casos financia ilegalmente a los agentes sociales GRÁFICO Los cursos de formación en España In English: Three decades of training program scams Álvaro de Cózar / Pilar Álvarez Madrid15 JUN 2014 - 16:32 CET542

Fuente: elaboración propia a partir de presupuestos de SEPE 2013 y normativa de Formación para el Empleo. / EL PAÍS “Investiguen, por favor. Hay mucha basura”. El mensaje, al final de una larga carta manuscrita, llegó a la redacción de EL PAÍS el pasado 13 de marzo, dos días después de que la policía detuviera en Córdoba y Madrid a una docena de personas vinculadas a la trama de los cursos de formación falsos, el llamado caso Aneri. El fraude, que implica a cargos de la patronal madrileña CEIM, había hecho desaparecer unos 17 millones de euros de subvenciones estatales y regionales con el sistema de asignar alumnos falsos a cursos online no impartidos. “Investiguen, por favor. Hay mucha basura”. El mensaje, al final de una larga carta manuscrita, llegó a la redacción de EL PAÍS en marzo Pero la frase (investiguen, por favor, hay mucha basura), al final de la citada carta, no se refería exclusivamente al caso del empresario cordobés. Su autor utilizaba el escándalo que estaba asaltando los titulares de los periódicos para remontarse a los orígenes de un sistema corrupto que dilapida año tras año millones de euros de fondos de la Seguridad Social y europeos. El hombre se identificaba con nombre y apellidos y relataba cómo las subvenciones de los cursos de formación servían para financiar a la patronal madrileña. El último párrafo daba detalles sobre cómo conocía todas esas 261

irregularidades. La Cámara de Comercio le contrató en el año 1991 para crear el departamento de Formación. Fue su primer director y se propuso cortar los abusos en la utilización de las subvenciones públicas. Pero recibió presiones: “Me machacaron a muerte. Recibí amenazas por todas partes. Cuando me negué a firmar pagos de salarios extraños, me echaron sin compasión alguna. Entré en tratamiento psiquiátrico. Hoy vivo lejos de Madrid, sin recuperarme de las secuelas”. La historia del exdirectivo ha sido confirmada por fuentes no oficiales de la Cámara de Comercio. El testimonio no aporta pruebas documentales pero confirma una sospecha que desde hace décadas está instalada en los círculos que gestionan la formación: que ese fondo común ha servido para financiar a las patronales y a algún sindicato, y que la Administración no ha establecido mecanismos eficaces para evitarlo.

El presidente de la Confederación de Empresarios de Galicia, Antonio Ramilo, tras anunciar su dimisión. / efe LA TARTA DE LOS CURSOS 21.000 millones en 10 años El mundo de la formación mueve miles de millones de euros cada año. Desde 2005 hasta ahora se han destinado en total de 21.000 millones de euros, según datos del Ministerio de Empleo. Todo ese dinero sale fundamentalmente de las cuotas que trabajadores y empresas destinan a la Seguridad Social, un 0,7% de la masa salarial. El resto lo hace de la administración central y de los fondos europeos. Las proporciones varían cada año, pero la mayor parte del dinero la aportan las cuotas destinadas a la Seguridad Social. Por ejemplo, en 2010, año en el que se destinaron 2.594 millones para la formación, el 84% procedía de la Seguridad Social, Europa dio un 10% (250 millones) y el Estado, un 6% (149 millones). El dinero lo gestionan las Comunidades Autónomas y el Servicio Público de Empleo Estatal (SEPE), que sacan todos los años convocatorias para subvencionar cursos de formación. Estas se conceden según un sistema de puntos que trata, supuestamente, de atender las demandas laborales. Sindicatos, patronales y asociaciones empresariales piden la mayor parte de esas ayudas, pero no suelen impartir directamente los cursos. Estos son subcontratados a academias y consultoras. Es en este punto cuando se reparte el pastel y empiezan los problemas.

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ALUMNOS FALSOS La estafa Con pequeñas diferencias a lo largo de los años, el modus operandi de las academias y consultoras que defraudan es siempre el mismo, según señalan los policías que llevan años investigando este tipo de estafas. Cuantos más alumnos tenga un determinado curso, más dinero se puede recibir. ¿Cómo los consiguen? Falsificando firmas de alumnos o recurriendo a bases de datos de personas reales para que consten como participantes. Esa es la forma de justificar luego ante las administraciones el gasto del dinero. La experiencia de los policías es que en la mayoría de los casos solo se impartía una pequeña parte de los cursos para dar una apariencia de legalidad. El resto eran falsos.

Alonso Tezanos, presidente de Cecoma, y Arturo Fernández, presidente de la patronal madrileña, en la firma de un convenio con Fedecam ¿Cómo se consigue que nadie se percate de que la mayoría de los alumnos son falsos? Es ahí donde entran en juego los cómplices y la colaboración de un sistema lleno de irregularidades. Para empezar, las consultoras devuelven parte del dinero a las entidades que han recibido las subvenciones de la administración. La ley permite que se devuelva a una patronal, por ejemplo, un 10% de la subvención en forma de gastos asociados a los cursos (la contratación de una telefonista que llama a los alumnos o los gastos de un aula si el curso se da en la sede propia). Bajo cuerda, las consultoras pueden retornar mucho más dinero con facturas falsas. La patronal en este caso encuentra así una forma de financiación a través de las ayudas públicas. Un ejemplo de todo esto es el caso Aneri. Según la investigación de la Sección de Investigación de la Seguridad Social de la Unidad de Delitos Económicos y Financieros (UDEF) de la Policía Nacional, la trama de los cursos de Madrid desmantelada en marzo repartía así la subvención. Imaginemos que era de 100 euros. De ellos, 20 se destinaban a mordidas para algunas asociaciones empresariales. Otra porción (10 euros) se destinaba a pagar el coste de la infraestructura: empleados, oficinas, plataformas, publicidad... El resto (70 euros) era ganancia neta para la consultora, aunque Aneri repartía también algo en fajos de billetes a los intermediarios de algunas asociaciones, según la investigación. “HOY VIENE EL INSPECTOR” Colaboración administrativa La otra pata que ha de funcionar para cerrar el círculo es que la administración no se dé cuenta de lo que ocurre. En algunos casos, la policía ha descubierto sobornos a funcionarios, inspectores de Trabajo y políticos. Pero en la mayoría de las ocasiones no 263

hace falta tal grado de implicación. Es suficiente con que la Administración mire para otro lado. Funcionarios públicos han denunciado a este diario la falta de controles sobre los cursos. “Cuando los inspectores van a un curso para ver si se está realizando, no cogen a nadie por sorpresa. Las academias saben siempre cuando van a llegar”, señala una de esas fuentes, que pide anonimato, como la mayoría de las personas consultadas para esta información. Cuantos más alumnos tenga un determinado curso, más dinero se puede recibir. ¿Cómo los consiguen? Falsificando firmas de alumnos o recurriendo a bases de datos Trabajadores de una organización empresarial madrileña implicada en el caso Aneri han corroborado este último punto a EL PAÍS: “Hoy viene el inspector de la Comunidad, nos decían, y sabíamos que iba a estar todo preparado para que ese día hubiera gente en los cursos”. Hay otro problema añadido. La vida de las ayudas públicas es de tres años. Una subvención para cursos que se convoca, por ejemplo en 2010, no se ejecuta hasta el año siguiente, es decir, los cursos se tienen que impartir en 2011. El momento de justificar y entregar todos los papeles que acrediten la veracidad del curso no llega hasta el año siguiente, 2012. Si la administración no detecta irregularidades, solo cabe que sean los tribunales de cuentas los que evalúen la gestión. Si lo hacen, suelen tardar algunos años más en revisarlo todo. LOS ORÍGENES Un sistema perverso Es imposible saber cuánto de todo el dinero concedido desde que se inició el sistema de la formación ha sido defraudado, pero los casos se han ido repitiendo año tras año. El sistema empezó a fraguarse en el año 1984. Patronal y sindicatos firmaron entonces el Acuerdo Económico y Social, un documento en el que se diagnosticaba que la causa del deficiente mercado laboral era la falta de formación de los trabajadores. La solución fue fijar unas cuotas que trabajadores y empresarios aportarían a la Seguridad Social y que se destinarían a cursos de formación. Para gestionar ese dinero y todo lo relacionado con la formación se creó en 1993 la Forcem (Fundación para la formación continua), un ente en el que estaban los sindicatos y las patronales. Además de administrar las subvenciones estatales, la Forcem también recibía fondos europeos. El sistema empezó a dar problemas desde el principio.

La Guardia Civil registra la sede de UGT Andalucía. / Julian Rojas (EL PAÍS) Los casos de corrupción empezaron a sucederse. En Madrid, saltó el caso del Imefe en 1998, en el que redes empresariales del PP con escasa o nula plantilla docente se habían 264

hecho desde 1996 con 8,41 millones. En 1999, dos profesores de las academias de Fidel Pallerols denunciaron una estafa con el uso de fondos comunitarios para formación de parados en Cataluña. Pallerols recibía fondos europeos a cambio de desviar dinero que iba a la financiación irregular de Unió Democràtica de Catalunya. En Galicia, el presidente de la patronal gallega, Antonio Ramilo, tuvo que dimitir en 2000 tras detectarse el desvío de 1.000 millones de pesetas (seis millones de euros) de subvenciones para sufragar gastos corrientes de la organización que presidía. Esas investigaciones fueron la antesala del caso Forcem (2002), el más famoso de la época y el que más recuerdan los investigadores. La Policía Judicial confirmó un fraude a la Unión Europea de unos 100 millones de euros en miles de cursos. La Audiencia Nacional llamó como imputados a empresarios de academias y sindicalistas de UGT. La Audiencia archivó la causa contra los sindicalistas y remitió el resto del caso a diferentes juzgados de instrucción. En algunos casos los delitos acabaron prescribiendo. “Después de la Forcem, pensé que nunca más vería un caso igual. Y ya ves”, dice un policía experto en este tipo de fraudes. LOS ROBOTS DE ANERI Los alumnos perfectos El sistema se cambió, la Forcem se sustituyó por la Fundación Tripartita, en la que además de los sindicatos y patronales estaba también el Estado. Pero los fraudes han seguido ocurriendo. En Andalucía, existen sospechas de que el sindicato UGT ha defraudado parte de los fondos públicos recibidos, unos siete millones de euros. En total se investigan 19 expedientes de 2008 a 2012. En Madrid, la policía destapó las irregularidades que había cometido Aneri en los cursos que hacía para varias organizaciones regionales y nacionales. La estafa en este caso era más sofisticada. Los cursos se hacen ahora en plataformas de Internet. Y ahí el descontrol es aún mayor. Cada vez que los técnicos se metían en las plataformas de Aneri, detectaban claves de alumnos que supuestamente hacían los cursos. Pero detrás no había nadie. En realidad era un programa informático el que multiplicaba los alumnos. El problema es que estos eran demasiado perfectos, poco humanos. Los alumnos reales suelen ajustarse al porcentaje de ejercicios exigidos para aprobar el curso, un 75%. Pero los alumnos imaginarios de Aneri los hacían todos.

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HERRAJES PARA CABALLOS La utilidad de los cursos Un vistazo rápido a algunos de los cursos que se ofrecen desde plataformas online demuestra que, aun sin fraudes, el sistema no cumple su cometido de formar a los trabajadores. La Confederación del Taxi de España, que firmó acuerdos con Aneri por los que cobraba mordidas del 20% de la subvención, organizaba cursos a distancia con los que se pretendía enseñar a los taxistas mecánica para conductores o el uso del GPS. Pero también se ofrecían cursos online para auxiliar de herrador de caballos. “Lo de la teleformación es una mentira. Lo sabe todo el mundo”, dice David M., un empresario de formación de Sevilla. “Lo primero que hacen las empresas informáticas cuando vienen a venderte una plataforma digital para dar cursos es decirte que la suya es fácilmente manipulable para falsear alumnos”, asegura el empresario. OTRA VUELTA DE TUERCA La nueva reforma Los últimos casos de corrupción —el más reciente en Málaga, donde la UDEF investiga a 20 empresas que recibieron 1,7 millones del Gobierno andaluz— coinciden con la negociación que el Ministerio de Empleo ha abierto con sindicatos y patronal para la enésima reforma de los cursos. En Alemania, la formación profesional de los trabajadores se realiza sobre todo dentro de las empresas y en su jornada laboral Francia modificó en marzo su normativa tras un escándalo de 2007 en la gestión de los fondos de formación por una patronal metalúrgica que malversó unos 20 millones. Se creó una comisión parlamentaria, se elaboró un informe muy crítico y diseñaron un sistema de financiación transparente de los agentes sociales separado de la formación. En Alemania, la formación profesional de los trabajadores se realiza sobre todo dentro de las empresas y en su jornada laboral. Allí, el gasto público tiene poca importancia en los programas. Los costes directos los paga el participante. Y, desde 2007, existe un programa adicional de financiación por el que los beneficiarios están obligados a invertir al menos el mismo dinero que reciben. España quiere ahora aplicar una adjudicación de cursos por concurso público y un sistema en el que participen directamente, sin intermediarios, tanto organizaciones sin ánimo de lucro como consultoras privadas. El tiempo dirá si es el cambio definitivo o una vez más todo cambia para que todo siga igual. FE DE ERRORES En una primera versión de este artículo se decía que en el caso Forcem (2002), un fraude de unos 100 millones de euros de los fondos europeos en miles de cursos, la Audiencia Nacional llamó como imputados a empresarios de academias y sindicalistas de UGT y que los delitos acabaron prescribiendo. El Juzgado Central de Instrucción número 3 de la Audiencia Nacional dictó un auto en junio de 2006 en el que se archivaba la causa para los seis sindicalistas imputados. La Audiencia remitió el resto del caso a diferentes juzgados de instrucción. Hubo más investigaciones relacionadas con el caso Forcem que afectaron a sindicalistas. La secretaria de la Administración de la Comisión Ejecutiva Provincial de FET-UGT en Cádiz fue condenada por la Audiencia Provincial como autora de un delito de falsedad en concurso y malversación a la pena de dos años y tres meses de prisión. El Tribunal Supremo, en una sentencia del 29 de diciembre de 2009, anuló la sentencia previa de la Audiencia Provincial y resolvió que la acusada, al no tratarse de una funcionaria pública, no podía incurrir en el tipo de malversación de caudales públicos, aún cuando hubiera gestionado subvenciones públicas. Ciñó sus delitos a una práctica de apropiación indebida, delito para el que sí habían prescrito los hechos. http://politica.elpais.com/politica/2014/06/15/actualidad/1402842749_308339.html 266

ANNALS OF ENTERPRISE THE DISRUPTION MACHINE What the gospel of innovation gets wrong. by Jill Lepore JUNE 23, 2014

Disruption is a theory of change founded on panic, anxiety, and shaky evidence. Illustration by Brian Stauffer. In the last years of the nineteen-eighties, I worked not at startups but at what might be called finish-downs. Tech companies that were dying would hire temps—college students and new graduates—to do what little was left of the work of the employees they’d laid off. This was in Cambridge, near M.I.T. I’d type users’ manuals, save them onto 5.25-inch floppy disks, and send them to a line printer that yammered like a set of prank-shop chatter teeth, but, by the time the last perforated page coiled out of it, the equipment whose functions those manuals explained had been discontinued. We’d work a month here, a week there. There wasn’t much to do. Mainly, we sat at our desks and wrote wishy-washy poems on keyboards manufactured by Digital Equipment Corporation, left one another sly messages on pink While You Were Out sticky notes, swapped paperback novels—Kurt Vonnegut, Margaret Atwood, Gabriel García Márquez, that kind of thing—and, during lunch hour, had assignations in empty, unlocked offices. At Polaroid, I once found a Bantam Books edition of “Steppenwolf” in a clogged sink in an employees’ bathroom, floating like a raft. “In his heart he was not a man, but a wolf of the steppes,” it said on the bloated cover. The rest was unreadable. Not long after that, I got a better assignment: answering the phone for Michael Porter, a professor at the Harvard Business School. I was an assistant to his assistant. In 1985, Porter had published a book called “Competitive Advantage,” in which he elaborated on the three strategies—cost leadership, differentiation, and focus—that he’d described in his 1980 book, “Competitive Strategy.” I almost never saw Porter, and, 267

when I did, he was dashing, affably, out the door, suitcase in hand. My job was to field inquiries from companies that wanted to book him for speaking engagements. “The Competitive Advantage of Nations” appeared in 1990. Porter’s ideas about business strategy reached executives all over the world. Porter was interested in how companies succeed. The scholar who in some respects became his successor, Clayton M. Christensen, entered a doctoral program at the Harvard Business School in 1989 and joined the faculty in 1992. Christensen was interested in why companies fail. In his 1997 book, “The Innovator’s Dilemma,” he argued that, very often, it isn’t because their executives made bad decisions but because they made good decisions, the same kind of good decisions that had made those companies successful for decades. (The “innovator’s dilemma” is that “doing the right thing is the wrong thing.”) As Christensen saw it, the problem was the velocity of history, and it wasn’t so much a problem as a missed opportunity, like a plane that takes off without you, except that you didn’t even know there was a plane, and had wandered onto the airfield, which you thought was a meadow, and the plane ran you over during takeoff. Manufacturers of mainframe computers made good decisions about making and selling mainframe computers and devising important refinements to them in their R. & D. departments—“sustaining innovations,” Christensen called them—but, busy pleasing their mainframe customers, one tinker at a time, they missed what an entirely untapped customer wanted, personal computers, the market for which was created by what Christensen called “disruptive innovation”: the selling of a cheaper, poorer-quality product that initially reaches less profitable customers but eventually takes over and devours an entire industry. Ever since “The Innovator’s Dilemma,” everyone is either disrupting or being disrupted. There are disruption consultants, disruption conferences, and disruption seminars. This fall, the University of Southern California is opening a new program: “The degree is in disruption,” the university announced. “Disrupt or be disrupted,” the venture capitalist Josh Linkner warns in a new book, “The Road to Reinvention,” in which he argues that “fickle consumer trends, friction-free markets, and political unrest,” along with “dizzying speed, exponential complexity, and mind-numbing technology advances,” mean that the time has come to panic as you’ve never panicked before. Larry Downes and Paul Nunes, who blog for Forbes, insist that we have entered a new and even scarier stage: “big bang disruption.” “This isn’t disruptive innovation,” they warn. “It’s devastating innovation.” Things you own or use that are now considered to be the product of disruptive innovation include your smartphone and many of its apps, which have disrupted businesses from travel agencies and record stores to mapmaking and taxi dispatch. Much more disruption, we are told, lies ahead. Christensen has co-written books urging disruptive innovation in higher education (“The Innovative University”), public schools (“Disrupting Class”), and health care (“The Innovator’s Prescription”). His acolytes and imitators, including no small number of hucksters, have called for the disruption of more or less everything else. If the company you work for has a chief innovation officer, it’s because of the long arm of “The Innovator’s Dilemma.” If your city’s public-school district has adopted an Innovation Agenda, which has disrupted the education of every kid in the city, you live in the shadow of “The Innovator’s Dilemma.” If you saw the episode of the HBO sitcom “Silicon Valley” in which the characters attend a conference called TechCrunch Disrupt 2014 (which is a real thing),

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and a guy from the stage, a Paul Rudd look-alike, shouts, “Let me hear it, DISSS- RUPPTTT!,” you have heard the voice of Clay Christensen, echoing across the valley. Last month, days after the Times’ publisher, Arthur Sulzberger, Jr., fired Jill Abramson, the paper’s executive editor, the Times’ 2014 Innovation Report was leaked. It includes graphs inspired by Christensen’s “Innovator’s Dilemma,” along with a lengthy, glowing summary of the book’s key arguments. The report explains, “Disruption is a predictable pattern across many industries in which fledgling companies use new technology to offer cheaper and inferior alternatives to products sold by established players (think Toyota taking on Detroit decades ago). Today, a pack of news startups are hoping to ‘disrupt’ our industry by attacking the strongest incumbent—The New York Times.” A pack of attacking startups sounds something like a pack of ravenous hyenas, but, generally, the rhetoric of disruption—a language of panic, fear, asymmetry, and disorder—calls on the rhetoric of another kind of conflict, in which an upstart refuses to play by the established rules of engagement, and blows things up. Don’t think of Toyota taking on Detroit. Startups are ruthless and leaderless and unrestrained, and they seem so tiny and powerless, until you realize, but only after it’s too late, that they’re devastatingly dangerous: Bang! Ka-boom! Think of it this way: the Times is a nation- state; BuzzFeed is stateless. Disruptive innovation is competitive strategy for an age seized by terror. Every age has a theory of rising and falling, of growth and decay, of bloom and wilt: a theory of nature. Every age also has a theory about the past and the present, of what was and what is, a notion of time: a theory of history. Theories of history used to be supernatural: the divine ruled time; the hand of God, a special providence, lay behind the fall of each sparrow. If the present differed from the past, it was usually worse: supernatural theories of history tend to involve decline, a fall from grace, the loss of God’s favor, corruption. Beginning in the eighteenth century, as the intellectual historian Dorothy Ross once pointed out, theories of history became secular; then they started something new—historicism, the idea “that all events in historical time can be explained by prior events in historical time.” Things began looking up. First, there was that, then there was this, and this is better than that. The eighteenth century embraced the idea of progress; the nineteenth century had evolution; the twentieth century had growth and then innovation. Our era has disruption, which, despite its futurism, is atavistic. It’s a theory of history founded on a profound anxiety about financial collapse, an apocalyptic fear of global devastation, and shaky evidence. Most big ideas have loud critics. Not disruption. Disruptive innovation as the explanation for how change happens has been subject to little serious criticism, partly because it’s headlong, while critical inquiry is unhurried; partly because disrupters ridicule doubters by charging them with fogyism, as if to criticize a theory of change were identical to decrying change; and partly because, in its modern usage, innovation is the idea of progress jammed into a criticism-proof jack-in-the-box. The idea of progress—the notion that human history is the history of human betterment—dominated the world view of the West between the Enlightenment and the First World War. It had critics from the start, and, in the last century, even people who cherish the idea of progress, and point to improvements like the eradication of contagious diseases and the education of girls, have been hard-pressed to hold on to it while reckoning with two World Wars, the Holocaust and Hiroshima, genocide and 269

global warming. Replacing “progress” with “innovation” skirts the question of whether a novelty is an improvement: the world may not be getting better and better but our devices are getting newer and newer. The word “innovate”—to make new—used to have chiefly negative connotations: it signified excessive novelty, without purpose or end. Edmund Burke called the French Revolution a “revolt of innovation”; Federalists declared themselves to be “enemies to innovation.” George Washington, on his deathbed, was said to have uttered these words: “Beware of innovation in politics.” Noah Webster warned in his dictionary, in 1828, “It is often dangerous to innovate on the customs of a nation.” The redemption of innovation began in 1939, when the economist Joseph Schumpeter, in his landmark study of business cycles, used the word to mean bringing new products to market, a usage that spread slowly, and only in the specialized literatures of economics and business. (In 1942, Schumpeter theorized about “creative destruction”; Christensen, retrofitting, believes that Schumpeter was really describing disruptive innovation.) “Innovation” began to seep beyond specialized literatures in the nineteen-nineties, and gained ubiquity only after 9/11. One measure: between 2011 and 2014, Time, the Times Magazine, The New Yorker, Forbes, and even Better Homes and Gardens published special “innovation” issues—the modern equivalents of what, a century ago, were known as “sketches of men of progress.” The idea of innovation is the idea of progress stripped of the aspirations of the Enlightenment, scrubbed clean of the horrors of the twentieth century, and relieved of its critics. Disruptive innovation goes further, holding out the hope of salvation against the very damnation it describes: disrupt, and you will be saved. Disruptive innovation as a theory of change is meant to serve both as a chronicle of the past (this has happened) and as a model for the future (it will keep happening). The strength of a prediction made from a model depends on the quality of the historical evidence and on the reliability of the methods used to gather and interpret it. Historical analysis proceeds from certain conditions regarding proof. None of these conditions have been met. “The Innovator’s Dilemma” consists of a set of handpicked case studies, beginning with the disk-drive industry, which was the subject of Christensen’s doctoral thesis, in 1992. “Nowhere in the history of business has there been an industry like disk drives,” Christensen writes, which makes it a very odd choice for an investigation designed to create a model for understanding other industries. The first hard-disk drive, which weighed more than a ton, was invented at I.B.M., in 1955, by a team that included Alan Shugart. Christensen is chiefly concerned with an era, beginning in the late nineteen- seventies, when disk drives decreased in size from fourteen inches to eight, then from eight to 5.25, from 5.25 to 3.5, and from 3.5 to 2.5 and 1.8. He counts a hundred and sixteen new technologies, and classes a hundred and eleven as sustaining innovations and five as disruptive innovations. Each of these five, he says, introduced “smaller disk drives that were slower and had lower capacity than those used in the mainstream market,” and each company that adopted them was an entrant firm that toppled an established firm. In 1973, Alan Shugart founded Shugart Associates, which introduced a 5.25-inch floppy-disk drive in 1976; the company was bought by Xerox the next year. In 1978, Shugart Associates developed an eight-inch hard-disk drive; Christensen, who is uninterested in the floppy-disk-drive industry, classes the company as an entrant firm and credits it with disrupting established firms that manufactured fourteen-inch hard 270

drives. In 1979, Alan Shugart founded Shugart Technology, which changed its name to Seagate Technology after Xerox threatened to sue. In 1980, Seagate Technology introduced the first 5.25-inch hard-disk drive; Christensen, at this point, classes Seagate as an entrant firm, and Shugart Associates as a failed incumbent, even though Shugart Associates was shifting its focus to what was then its very profitable floppy-disk-drive business. In the mid-eighties, Seagate—here considered by Christensen to be an established firm—delayed manufacturing 3.5-inch drives, which were valued by producers of portable computers and laptops, because its biggest customer, I.B.M., didn’t want them; I.B.M. wanted a better and faster version of the 5.25-inch drive for its full-sized desktop computers. Seagate didn’t start shipping 3.5-inch drives until 1988, and by then, Christensen argues, it was too late. In his original research, Christensen established the cutoff for measuring a company’s success or failure as 1989 and explained that “ ‘successful firms’ were arbitrarily defined as those which achieved more than fifty million dollars in revenues in constant 1987 dollars in any single year between 1977 and 1989—even if they subsequently withdrew from the market.” Much of the theory of disruptive innovation rests on this arbitrary definition of success. In fact, Seagate Technology was not felled by disruption. Between 1989 and 1990, its sales doubled, reaching $2.4 billion, “more than all of its U.S. competitors combined,” according to an industry report. In 1997, the year Christensen published “The Innovator’s Dilemma,” Seagate was the largest company in the disk-drive industry, reporting revenues of nine billion dollars. Last year, Seagate shipped its two- billionth disk drive. Most of the entrant firms celebrated by Christensen as triumphant disrupters, on the other hand, no longer exist, their success having been in some cases brief and in others illusory. (The fleeting nature of their success is, of course, perfectly consistent with his model.) Between 1982 and 1984, Micropolis made the disruptive leap from eight-inch to 5.25-inch drives through what Christensen credits as the “Herculean managerial effort” of its C.E.O., Stuart Mahon. (“Mahon remembers the experience as the most exhausting of his life,” Christensen writes.) But, shortly thereafter, Micropolis, unable to compete with companies like Seagate, failed. MiniScribe, founded in 1980, started out selling 5.25-inch drives and saw quick success. “That was MiniScribe’s hour of glory,” the company’s founder later said. “We had our hour of infamy shortly after that.” In 1989, MiniScribe was investigated for fraud and soon collapsed; a report charged that the company’s practices included fabricated financial reports and “shipping bricks and scrap parts disguised as disk drives.” As striking as the disruption in the disk-drive industry seemed in the nineteen- eighties, more striking, from the vantage of history, are the continuities. Christensen argues that incumbents in the disk-drive industry were regularly destroyed by newcomers. But today, after much consolidation, the divisions that dominate the industry are divisions that led the market in the nineteen-eighties. (In some instances, what shifted was their ownership: I.B.M. sold its hard-disk division to Hitachi, which later sold its division to Western Digital.) In the longer term, victory in the disk-drive industry appears to have gone to the manufacturers that were good at incremental improvements, whether or not they were the first to market the disruptive new format. Companies that were quick to release a new product but not skilled at tinkering have tended to flame out.

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Other cases in “The Innovator’s Dilemma” are equally murky. In his account of the mechanical-excavator industry, Christensen argues that established companies that built cable-operated excavators were slow to recognize the importance of the hydraulic excavator, which was developed in the late nineteen-forties. “Almost the entire population of mechanical shovel manufacturers was wiped out by a disruptive technology—hydraulics—that the leaders’ customers and their economic structure had caused them initially to ignore,” he argues. Christensen counts thirty established companies in the nineteen-fifties and says that, by the nineteen-seventies, only four had survived the entrance into the industry of thirteen disruptive newcomers, including Caterpillar, O. & K., Demag, and Hitachi. But, in fact, many of Christensen’s “new entrants” had been making cable-operated shovels for years. O. & K., founded in 1876, had been making them since 1908; Demag had been building excavators since 1925, when it bought a company that built steam shovels; Hitachi, founded in 1910, sold cable-operated shovels before the Second World War. Manufacturers that were genuinely new to excavation equipment tended to sell a lot of hydraulic excavators, if they had a strong distribution network, and then not do so well. And some established companies disrupted by hydraulics didn’t do half as badly as Christensen suggests. Bucyrus is the old-line shovel-maker he writes about most. It got its start in Ohio, in 1880, built most of the excavators that dug the Panama Canal, and became Bucyrus-Erie in 1927, when it bought the Erie Steam Shovel Company. It acquired a hydraulics- equipment firm in 1948, but, Christensen writes, “faced precisely the same problem in marketing its hydraulic backhoe as Seagate had faced with its 3.5-inch drives.” Unable to persuade its established consumers to buy a hydraulic excavator, Bucyrus introduced a hybrid product, called the Hydrohoe, in 1951—a merely sustaining innovation. Christensen says that Bucyrus “logged record profits until 1966—the point at which the disruptive hydraulics technology had squarely intersected with customers’ needs,” and then began to decline. “This is typical of industries facing a disruptive technology,” he explains. “The leading firms in the established technology remain financially strong until the disruptive technology is, in fact, in the midst of their mainstream market.” But, actually, between 1962 and 1979 Bucyrus’s sales grew sevenfold and its profits grew twenty-five-fold. Was that so bad? In the nineteen-eighties, Bucyrus suffered. The whole construction-equipment industry did: it was devastated by recession, inflation, the oil crisis, a drop in home building, and the slowing of highway construction. (Caterpillar sustained heavy losses, too.) In the early nineteen-nineties, after a disastrous leveraged buyout handled by Goldman Sachs, Bucyrus entered Chapter 11 protection, but it made some sizable acquisitions when it emerged, as Bucyrus International, and was a leading maker of mining equipment, just as it had been a century earlier. Was it a failure? Caterpillar didn’t think so when, in 2011, it bought the firm for nearly nine billion dollars. Christensen’s sources are often dubious and his logic questionable. His single citation for his investigation of the “disruptive transition from mechanical to electronic motor controls,” in which he identifies the Allen-Bradley Company as triumphing over four rivals, is a book called “The Bradley Legacy,” an account published by a foundation established by the company’s founders. This is akin to calling an actor the greatest talent in a generation after interviewing his publicist. “Use theory to help guide data collection,” Christensen advises.

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He finds further evidence of his theory in the disruption of the department store by the discount store. “Just as in disk drives and excavators,” he writes, “a few of the leading traditional retailers—notably S. S. Kresge, F. W. Woolworth, and Dayton Hudson—saw the disruptive approach coming and invested early.” In 1962, Kresge (which traces its origins to 1897) opened Kmart; Dayton-Hudson (1902) opened Target; and Woolworth (1879) opened Woolco. Kresge and Dayton-Hudson ran their discount stores as independent organizations; Woolworth ran its discount store in-house. Kmart and Target succeeded; Woolco failed. Christensen presents this story as yet more evidence of an axiom derived from the disk-drive industry: “two models for how to make money cannot peacefully coexist within a single organization.” In the mid- nineteen-nineties, Kmart closed more than two hundred stores, a fact that Christensen does not include in his account of the industry’s history. (Kmart filed for bankruptcy in 2002.) Only in a footnote does he make a vague allusion to Kmart’s troubles—“when this book was being written, Kmart was a crippled company”—and then he dismisses this piece of counter-evidence by fiat: “Kmart’s present competitive struggles are unrelated to Kresge’s strategy in meeting the original disruptive threat of discounting.” In his discussion of the steel industry, in which he argues that established companies were disrupted by the technology of minimilling (melting down scrap metal to make cheaper, lower-quality sheet metal), Christensen writes that U.S. Steel, founded in 1901, lowered the cost of steel production from “nine labor-hours per ton of steel produced in 1980 to just under three hours per ton in 1991,” which he attributes to the company’s “ferociously attacking the size of its workforce, paring it from more than 93,000 in 1980 to fewer than 23,000 in 1991,” in order to point out that even this accomplishment could not stop the coming disruption. Christensen tends to ignore factors that don’t support his theory. Factors having effects on both production and profitability that Christensen does not mention are that, between 1986 and 1987, twenty-two thousand workers at U.S. Steel did not go to work, as part of a labor action, and that U.S. Steel’s workers are unionized and have been for generations, while minimill manufacturers, with their newer workforces, are generally non-union. Christensen’s logic here seems to be that the industry’s labor arrangements can have played no role in U.S. Steel’s struggles— and are not even worth mentioning—because U.S. Steel’s struggles must be a function of its having failed to build minimills. U.S. Steel’s struggles have been and remain grave, but its failure is by no means a matter of historical record. Today, the largest U.S. producer of steel is—U.S. Steel. The theory of disruption is meant to be predictive. On March 10, 2000, Christensen launched a $3.8-million Disruptive Growth Fund, which he managed with Neil Eisner, a broker in St. Louis. Christensen drew on his theory to select stocks. Less than a year later, the fund was quietly liquidated: during a stretch of time when the Nasdaq lost fifty per cent of its value, the Disruptive Growth Fund lost sixty-four per cent. In 2007, Christensen told Business Week that “the prediction of the theory would be that Apple won’t succeed with the iPhone,” adding, “History speaks pretty loudly on that.” In its first five years, the iPhone generated a hundred and fifty billion dollars of revenue. In the preface to the 2011 edition of “The Innovator’s Dilemma,” Christensen reports that, since the book’s publication, in 1997, “the theory of disruption continues to yield predictions that are quite accurate.” This is less because people have used his model to make accurate predictions about things that haven’t happened yet than because disruption has been sold as advice, and because much that happened between 1997 and 2011 looks, in retrospect, disruptive. Disruptive innovation can reliably be seen only

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after the fact. History speaks loudly, apparently, only when you can make it say what you want it to say. The popular incarnation of the theory tends to disavow history altogether. “Predicting the future based on the past is like betting on a football team simply because it won the Super Bowl a decade ago,” Josh Linkner writes in “The Road to Reinvention.” His first principle: “Let go of the past.” It has nothing to tell you. But, unless you already believe in disruption, many of the successes that have been labelled disruptive innovation look like something else, and many of the failures that are often seen to have resulted from failing to embrace disruptive innovation look like bad management. Christensen has compared the theory of disruptive innovation to a theory of nature: the theory of evolution. But among the many differences between disruption and evolution is that the advocates of disruption have an affinity for circular arguments. If an established company doesn’t disrupt, it will fail, and if it fails it must be because it didn’t disrupt. When a startup fails, that’s a success, since epidemic failure is a hallmark of disruptive innovation. (“Stop being afraid of failure and start embracing it,” the organizers of FailCon, an annual conference, implore, suggesting that, in the era of disruption, innovators face unprecedented challenges. For instance: maybe you made the wrong hires?) When an established company succeeds, that’s only because it hasn’t yet failed. And, when any of these things happen, all of them are only further evidence of disruption. The handpicked case study, which is Christensen’s method, is a notoriously weak foundation on which to build a theory. But, if the handpicked case study is the approved approach, it would seem that efforts at embracing disruptive innovation are often fatal. Morrison-Knudsen, an engineering and construction firm, got its start in 1905 and helped build more than a hundred and fifty dams all over the world, including the Hoover. Beginning in 1988, a new C.E.O., William Agee, looked to new products and new markets, and, after Bill Clinton’s election, in 1992, bet on mass transit, turning to the construction of both commuter and long-distance train cars through two subsidiaries, MK Transit and MK Rail. These disruptive businesses proved to be a disaster. Morrison-Knudsen announced in 1995 that it had lost three hundred and fifty million dollars, by which point the company had essentially collapsed—not because it didn’t disruptively innovate but because it did. Time, Inc., founded in 1922, auto- disrupted, too. In 1994, the company launched Pathfinder, an early new-media venture, an umbrella Web site for its magazines, at a cost estimated to have exceeded a hundred million dollars; the site was abandoned in 1999. Had Pathfinder been successful, it would have been greeted, retrospectively, as evidence of disruptive innovation. Instead, as one of its producers put it, “it’s like it never existed.” In the late nineteen-nineties and early two-thousands, the financial-services industry innovated by selling products like subprime mortgages, collateralized debt obligations, and mortgage-backed securities, some to a previously untapped customer base. At the time, Ed Clark was the C.E.O. of Canada’s TD Bank, which traces its roots to 1855. Clark, who earned a Ph.D. in economics at Harvard with a dissertation on public investment in Tanzania, forswore Canada’s version of this disruptive innovation, asset- backed commercial paper. The decision made TD Bank one of the strongest banks in the world. Between 2002 and 2012, TD Bank’s assets increased from $278 billion to $806 billion. Since 2005, TD Bank has opened thirteen hundred branches in the United States, bought Commerce Bank for $8.5 billion, in 2008, and adopted the motto “America’s Most Convenient Bank.” With the money it earned by expanding its 274

traditional banking services—almost four billion dollars a year during the height of the financial crisis, according to the Canadian business reporter Howard Green—it set about marketing itself as the bank with the longest hours, the best teller services, and free dog biscuits. When the financial-services industry disruptively innovated, it led to a global financial crisis. Like the bursting of the dot-com bubble, the meltdown didn’t dim the fervor for disruption; instead, it fuelled it, because these products of disruption contributed to the panic on which the theory of disruption thrives. Disruptive innovation as an explanation for how change happens is everywhere. Ideas that come from business schools are exceptionally well marketed. Faith in disruption is the best illustration, and the worst case, of a larger historical transformation having to do with secularization, and what happens when the invisible hand replaces the hand of God as explanation and justification. Innovation and disruption are ideas that originated in the arena of business but which have since been applied to arenas whose values and goals are remote from the values and goals of business. People aren’t disk drives. Public schools, colleges and universities, churches, museums, and many hospitals, all of which have been subjected to disruptive innovation, have revenues and expenses and infrastructures, but they aren’t industries in the same way that manufacturers of hard- disk drives or truck engines or drygoods are industries. Journalism isn’t an industry in that sense, either. Doctors have obligations to their patients, teachers to their students, pastors to their congregations, curators to the public, and journalists to their readers—obligations that lie outside the realm of earnings, and are fundamentally different from the obligations that a business executive has to employees, partners, and investors. Historically, institutions like museums, hospitals, schools, and universities have been supported by patronage, donations made by individuals or funding from church or state. The press has generally supported itself by charging subscribers and selling advertising. (Underwriting by corporations and foundations is a funding source of more recent vintage.) Charging for admission, membership, subscriptions and, for some, earning profits are similarities these institutions have with businesses. Still, that doesn’t make them industries, which turn things into commodities and sell them for gain. In “The Innovative University,” written with Henry J. Eyring, who used to work at the Monitor Group, a consulting firm co-founded by Michael Porter, Christensen subjected Harvard, a college founded by seventeenth-century theocrats, to his case- study analysis. “Studying the university’s history,” Christensen and Eyring wrote, “will allow us to move beyond the forlorn language of crisis to hopeful and practical strategies for success.” On the basis of this research, Christensen and Eyring’s recommendations for the disruption of the modern university include a “mix of face-to- face and online learning.” The publication of “The Innovative University,” in 2011, contributed to a frenzy for Massive Open Online Courses, or MOOCs, at colleges and universities across the country, including a collaboration between Harvard and M.I.T., which was announced in May of 2012. Shortly afterward, the University of Virginia’s panicked board of trustees attempted to fire the president, charging her with jeopardizing the institution’s future by failing to disruptively innovate with sufficient speed; the vice-chair of the board forwarded to the chair a Times column written by David Brooks, “The Campus Tsunami,” in which he cited Christensen.

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Christensen and Eyring’s recommendation of a “mix of face-to-face and online learning” was drawn from an investigation that involves a wildly misguided attempt to apply standards of instruction in the twenty-first century to standards of instruction in the seventeenth. One table in the book, titled “Harvard’s Initial DNA, 1636-1707,” looks like this: Initial Traits Implications Small, face-to-face classes High faculty-student intimacy Low instructional efficiency

Classical, religious instruction High moral content in the curriculum Narrow curriculum with low practicality for non-pastors

Nonspecialized faculty Dogmatic instruction High faculty empathy for learners

Low faculty expertise

In 2014, there were twenty-one thousand students at Harvard. In 1640, there were thirteen. The first year classes were held, Harvard students and their “nonspecialized faculty” (one young schoolmaster, Nathaniel Eaton), enjoying “small, face-to-face classes” (Eaton’s wife, who fed the students, was accused of putting “goat’s dung in their hasty pudding”) with “high faculty empathy for learners” (Eaton conducted thrashings with a stick of walnut said to have been “big enough to have killed a horse”), could have paddled together in a single canoe. That doesn’t mean good arguments can’t be made for online education. But there’s nothing factually persuasive in this account of its historical urgency and even inevitability, which relies on a method well outside anything resembling plausible historical analysis. Christensen and Eyring also urge universities to establish “heavyweight innovation teams”: Christensen thinks that R. & D. departments housed within a business and accountable to its executives are structurally unable to innovate disruptively—they are preoccupied with pleasing existing customers through incremental improvement. Christensen argues, for instance, that if Digital Equipment Corporation, which was doing very well making minicomputers in the nineteen-sixties and seventies, had founded, in the eighties, a separate company at another location to develop the personal computer, it might have triumphed. The logic of disruptive innovation is the logic of the startup: establish a team of innovators, set a whiteboard under a blue sky, and never ask them to make a profit, because there needs to be a wall of separation between the people whose job is to come up with the best, smartest, and most creative and important ideas and the people whose job is to make money by selling stuff. Interestingly, a similar principle has existed, for more than a century, in the press. The “heavyweight innovation team”? That’s what journalists used to call the “newsroom.” It’s readily apparent that, in a democracy, the important business interests of institutions like the press might at times conflict with what became known as the “public interest.” That’s why, a very long time ago, newspapers like the Times and magazines like this one established a wall of separation between the editorial side of affairs and the business side. (The metaphor is to the Jeffersonian wall between church and state.) “The wall dividing the newsroom and business side has served The Times well for decades,” according to the Times’ Innovation Report, “allowing one side to focus on readers and the other to focus on advertisers,” as if this had been, all along,

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simply a matter of office efficiency. But the notion of a wall should be abandoned, according to the report, because it has “hidden costs” that thwart innovation. Earlier this year, the Times tried to recruit, as its new head of audience development, Michael Wertheim, the former head of promotion at the disruptive media outfit Upworthy. Wertheim turned the Times job down, citing its wall as too big an obstacle to disruptive innovation. The recommendation of the Innovation Report is to understand that both sides, editorial and business, share, as their top priority, “Reader Experience,” which can be measured, following Upworthy, in “Attention Minutes.” Vox Media, a digital- media disrupter that is mentioned ten times in the Times report and is included, along with BuzzFeed, in a list of the Times’ strongest competitors (few of which are profitable), called the report “brilliant,” “shockingly good,” and an “insanely clear” explanation of disruption, but expressed the view that there’s no way the Times will implement its recommendations, because “what the report doesn’t mention is the sobering conclusion of Christensen’s research: companies faced with disruptive threats almost never manage to handle them gracefully.” Disruptive innovation is a theory about why businesses fail. It’s not more than that. It doesn’t explain change. It’s not a law of nature. It’s an artifact of history, an idea, forged in time; it’s the manufacture of a moment of upsetting and edgy uncertainty. Transfixed by change, it’s blind to continuity. It makes a very poor prophet. The upstarts who work at startups don’t often stay at any one place for very long. (Three out of four startups fail. More than nine out of ten never earn a return.) They work a year here, a few months there—zany hours everywhere. They wear jeans and sneakers and ride scooters and share offices and sprawl on couches like Great Danes. Their coffee machines look like dollhouse-size factories. They are told that they should be reckless and ruthless. Their investors, if they’re like Josh Linkner, tell them that the world is a terrifying place, moving at a devastating pace. “Today I run a venture capital firm and back the next generation of innovators who are, as I was throughout my earlier career, dead-focused on eating your lunch,” Linkner writes. His job appears to be to convince a generation of people who want to do good and do well to learn, instead, remorselessness. Forget rules, obligations, your conscience, loyalty, a sense of the commonweal. If you start a business and it succeeds, Linkner advises, sell it and take the cash. Don’t look back. Never pause. Disrupt or be disrupted. But they do pause and they do look back, and they wonder. Meanwhile, they tweet, they post, they tumble in and out of love, they ponder. They send one another sly messages, touching the screens of sleek, soundless machines with a worshipful tenderness. They swap novels: David Foster Wallace, Chimamanda Ngozi Adichie, Zadie Smith. “Steppenwolf” is still available in print, five dollars cheaper as an e-book. He’s a wolf, he’s a man. The rest is unreadable. So, as ever, is the future. ♦

Read more: http://www.newyorker.com/reporting/2014/06/23/140623fa_fact_lepore?currentPage=al l

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June 17, 2014 Economics World Cup: Stagnationists 1, Optimists 0 Posted by John Cassidy

As the initial series of matches in Brazil draws to an end—and what a series it was—the economics world is also enjoying a clash of heavyweights. In a matchup over the future of the U.S. economy, the Secular Stagnationists are taking on the Good Old-Fashioned Optimists. At this point, midway through the first half, the Stagnationists appear to be ahead, but there is a long way to go. It’s an eagerly awaited contest between two teams whose prognostications investors and other spectators around the globe watch keenly. Both clubs have somewhat checkered records—all economic forecasters do, to some extent—but they are both stocked with talented and generously recompensed players. The Stagnationists’ team captain is Larry Summers, formerly the director of President Obama’s National Economic Council; the Optimists are led by the current chairman of the White House Council of Economic Advisers, Jason Furman. Late last year, Summers kicked up quite a fuss with his suggestion that the U.S. and other major economies, pinned down by the zero-bound of interest rates—that is, the impracticability of lowering them below zero—might well be in for an extended period of subpar growth. Still, as 2014 began, the Optimists seemed to have good reasons for being positive. With unemployment falling, household debt ratios stabilizing, and fiscal drag easing, there were some persuasive arguments to believe that 2014 would finally be the year when the economy shook off the aftereffects of the Great Recession. This thinking was reflected in the projections that many economists released. In its budget documents, the White House predicted that the rate of G.D.P. growth would 278

reach 3.1 per cent in 2014, and 3.4 per cent in 2015, up from 1.9 per cent last year. Another star player on the Optimists, Jan Hatzius, the chief economist at Goldman Sachs, predicted a similar uptick in G.D.P. growth. Even the ever-cautious International Monetary Fund, in its 2014 forecast, said that the growth rate could come in at 2.8 per cent. That was before the drawn-out winter made a mockery of practically everybody’s prognostications, mine included. Largely as a result of the frozen weather, the economy contracted by 0.6 per cent on an annualized basis between January and March, according to the Commerce Department. Since then, spending has rebounded in many sectors, but it’s still not clear whether the economy can attain the sort of vigor that the Optimists had been hoping. On Tuesday, the I.M.F. slashed its 2014 G.D.P. forecast, saying that growth would be restricted to two per cent, which means it would be basically flat. (Last year, G.D.P. expanded by 1.9 per cent.) Although the fund conceded that, after the first-quarter shock, “a meaningful rebound in activity is now underway,” it said that unemployment wouldn’t return to normal levels before the end of 2017, and that inflation would remain below the Fed’s target of two per cent. Indeed, the I.M.F.’s analysis was so gloomy that it raised the prospect of the Fed keeping interest rates at their current ultra-low levels for longer than markets are expecting—which could, in turn, cause a buildup of financial risks. And that wasn’t all. The Washington-based nabobs of negativity reduced their estimate of the U.S. economy’s “potential growth rate”—i.e., the rate it can sustain over the longer term—to just two per cent. “A combination of factors is at work in lowering longer-run growth including the effects of population aging and more modest prospects for productivity growth,” the I.M.F. said. “This puts a significant premium on taking immediate steps to raise productivity, encourage innovation, augment human and physical capital, and increase labor force participation.” All in all, the report was a sobering one. But it’s not all doom and gloom. Last week, Hatzius, who is renowned for his warnings about the housing market in 2007-2008, went on CNBC and reiterated his prediction that G.D.P. growth could hit three per cent in the coming months—a rate that, if sustained, would be the highest since the Great Recession started, in late 2007. In a research note to Goldman’s clients, Hatzius explained why he is still bullish. “The broader rationale for stronger growth in 2014- 2015 … remains intact. The fiscal policy drag of 2013 has ended. The household sector debt/income ratio seems to have bottomed. And while we recently shaved our homebuilding numbers a bit, our forecast remains one of recovery.” Whose side am I taking in this game? Like Hatzius, I think the rebound in spending is likely to be sustained for some time. Car sales, which are a good gauge of consumer confidence, are surging. The pace of job growth has stepped up in recent months. And consumer credit expanded at an annual rate of more than ten per cent in April, the fastest rate since the end of the recession. In the long run, rapid credit growth can be disastrous. In the short term, though, there’s no doubt it gives the economy a boost. I wouldn’t be surprised if G.D.P. growth for the remainder of the year were to be a positive surprise, producing a dramatic shift in market expectations about Fed policy and delivering an equalizer for the Optimists. I should admit, though, that I have been saying this for quite a while now, and the takeoff has failed to materialize. I should also note that even some of those predicting an upsurge aren’t exactly cooing over the U.S. 279

economy’s long-term prospects. Take Hatzius. Despite Goldman’s upbeat outlook for the immediate future, the firm’s estimate of the economy’s growth potential is just 2.25 per cent. That’s not too different from what the I.M.F. is saying. This match could well end in a tie. Photograph by Andrew Harrer/Bloomberg via Getty. http://www.newyorker.com/online/blogs/johncassidy/2014/06/economics-world-cup- secular-stagnationists-1-optimists-0.html

ft.com UK Politics & Policy Last updated:June 17, 2014 10:23 pm Germany seeks to avoid clash at Ypres over Juncker job By George Parker in London, Peter Spiegel in Brussels and Stefan Wagstyl in Berlin

©Getty The prospect of Britain losing out to Germany in a row over Brussels jobs at an EU summit in Ypres, the first world war battlefield, has sent European officials scrambling to avert a public relations disaster. Angela Merkel, German chancellor, has told colleagues she wants to seal the appointment of Jean-Claude Juncker as European Commission president at the summit, threatening a defeat for David Cameron, who had publicly opposed his candidacy. More ON THIS TOPIC// Major sees silver lining in Juncker row/ Cameron asks for ‘courage’ in opposing Juncker/ Tory backbencher to try to force referendum/ Editorial Cameron’s flawed tactics on Europe IN UK POLITICS & POLICY// NHS urged to cut costs like Tesco/ Osborne ‘broke rules’ with Help To Buy/ MPs seek boost for poor white pupils/ Hospital pay plan for reporting EU patients But the depressing symbolism of Britain and Germany becoming embroiled in a dispute in Ypres, a Belgian town devastated in the first world war, is raising concerns among EU diplomats. Herman Van Rompuy, the Belgian president of the European Council, is trying to find ways of stopping a “solemn occasion” of remembrance turning into a diplomatic humiliation for Britain.

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Berlin has also raised concerns over the risk of political clashes at Ypres. One option being considered by Mr Van Rompuy is for the discussion of EU jobs to be postponed to a separate summit at a later date. Mr Cameron has called on EU reformers to “stand up and be counted” but he has few allies in his campaign to stop the appointment of Mr Juncker, whom he views as a federalist. The prime minister hinted at a sense of impending defeat on Tuesday when he said: “I will go on thinking it is wrong right up until the end.” A spokesman for Mr Van Rompuy said he hoped the Ypres dinner would focus on a pre-agreed statement on future EU priorities in an attempt to delay a debate on top jobs until day two of the summit, which will be held in its normal Brussels location. But the event would inevitably be overshadowed by the bitter dispute over Mr Juncker’s proposed appointment as European Commission president, with Mr Cameron looking increasingly isolated. Mr Van Rompuy’s proposal to send the leaders home only for them to be reconvened within days to hold the jobs discussion has attracted scorn from British diplomats. “It’s a complete waste of taxpayers’ money”, said one. “He hasn’t made up his mind,” said a second senior EU official. “The reason to go to Ypres is the symbolism of the place. It’s a special event in a special place. It’s not where you want to have a fight on the name of the commission president.” http://www.ft.com/cms/s/0/ff0d439a-f62f-11e3-83d3- 00144feabdc0.html#axzz34z7X5JC1

ft.com Comment Opinion June 17, 2014 3:55 pm Clearing houses could be the next source of chaos By Simon Johnson We have built them up as an officially sanctioned form of credit protection, writes Simon Johnson Financial shadows are dangerous. Even more dangerous are interactions between poorly understood shadows and essential financial intermediation activities. And most dangerous is when officials and private sector executives encourage a class of transactions that supposedly provide modest risk mitigation, while really building a disguised form of systemic risk on a grand scale. It was not mounting losses at Countrywide, the failure of Lehman Brothers or the imminent collapse of AIG that spelt disaster in September 2008. It was the connections between those lightly regulated businesses and Citigroup, Bank of America, Goldman Sachs, Société Générale, Barclays, UBS and Deutsche Bank. More ON THIS STORY// Shadow banks step into the lending void/ Banks unload risk into blind pools/ Fed looks at exit fees on bond funds/ Into the shadows Taking another path/ Comment Make shadow banks safe

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IN OPINION// China will profit from feeding the world’s appetite/ China’s currency push/ Time to focus a light on shadow banking/ Richard Haass A recast Middle East evolves Where is the next generation of systemic risk hiding in plain sight? Look carefully at central clearing counterparties, or clearing houses, which are expanding due to the post- crisis requirement that standardised swaps – derivative transactions, including credit default swaps, that have standard terms along important dimensions – be cleared centrally. Clearing houses are an old and simple idea: a collective entity takes on at least some of the credit risk otherwise associated with trading; you receive a claim on the clearing house as part of a cleared transaction with a counterparty. This should provide greater assurance that you will be paid, reducing the risk of a run on any financial institution or broader loss of confidence. The clearing house in turn holds collateral from transactions, has a guarantee fund provided by members and is backed by some equity capital. But is this really how it will work? Loading risk on to any private entity is not the same thing as having state-backed deposit insurance or a central banking liquidity backstop. In fact, this is why clearing houses made way for central banks more than 100 years ago. In a real panic, either you have access to the balance sheet of the government and the credibility of the central bank or you do not. There is no halfway house. BlackRock, the asset manager, is uncomfortable with clearing houses because their resolution process is unclear – we do not know who will be paid out in a bankruptcy and in what order of precedence. Loading risk on to any private entity is not the same thing as having state-backed deposit insurance or a central banking liquidity backstop Clearing houses function fine in calm conditions and this kind of structure has worked well in some markets for a long time. But in a system-wide storm, there is a danger we will end up back where we were in 2008: either the government will need to provide some form of bailout or we risk global meltdown. In effect, we have built up clearing houses as an officially sanctioned form of credit protection, along the lines of AIG or state-backed mortgage finance lenders Fannie Mae and Freddie Mac. And no one feels good about where that led – to big distortions in the pricing of risk. The intentions are good. But bilateral over-the-counter derivatives transactions, whereby parties trade with each other directly, can become a problem when people fear for systemic stability. Concentrating risk with the laudable goal of reducing opaqueness means that these clearing houses have, in effect, become too big to fail. It is hard to refute the logical implication: clearing houses should be subject to more stringent oversight. They should be funded with a great deal of equity relative to the potential losses. BlackRock calls for clearing houses to be allowed to fail while arguing “end investors should be protected” from any such failure. Who will step in to fill any liquidity gap, or even to provide support in the face of potential insolvency? Under current arrangements, the answer is the US government and presumably the Federal Reserve, along with other relevant central banks and governments for transactions in currencies other than the dollar. (All G20 countries have agreed to this approach.) 282

For more than a century, we have recognised that the availability of central bank liquidity support creates the potential for serious moral hazard. This is the logic behind the development of bank regulation. Clearing houseseither have ultimate official support, in which case the implied moral hazard is enormous; or they will be allowed to fail, making the post-Lehman chaos look relatively benign. Eight financial market utilities in the US have been designated as “systemic” under the Dodd-Frank Act. But they are not subject to the tougher prudential requirements in title I of that act. We have again created the perception of risk mitigation, while allowing ambiguity to develop about who will bear what kind of risk. The writer is a professor at the MIT Sloan School of Management and a former chief economist of the IMF http://www.ft.com/intl/cms/s/0/f0a6de48-f322-11e3-a3f8- 00144feabdc0.html#axzz34z7X5JC1

ft.com comment Columnists June 17, 2014 4:44 pm A climate fix would ruin investors

By Martin Wolf Humanity is making risky climate bets and ExxonMobil will probably be proved right

©James Ferguson/FT How much of the world’s fossil fuel reserves will eventually be burnt? This is not just a question for those concerned with climate policy. It is also a question for investors even if they believe (absurdly, in my view) that the science of climate change is a hoax. What, they must ask themselves, would it mean for my investments in fossil fuel exploration and production if policy makers acted on their expressed belief in the science of climate change? Where would that leave investments in companies that own reserves today and are investing in exploration and additional production for tomorrow? Might all this spending prove a disastrous waste of resources that would be better deployed elsewhere?

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More ON THIS STORY// FT Data How the global energy market is changing/ Germany backs EU energy target/ Nick Butler China and the UK/ US states consider carbon trading schemes/ IEA warns on Opec oil production risks ON THIS TOPIC// Solar power sector hopes emission bid will light way/ Renewable sources key to lower energy costs/ Pickles clamps down on onshore wind farms/ Large solar farms face subsidy blow MARTIN WOLF// UK has to be in or out of EU/ Events that shaped our world/ Martin Wolf Another rabbit from the hat/ Business unlocks growth Unburnable Carbon 2013, a report produced by London-based non-governmental organisation Carbon Tracker and the Grantham Research Institute on Climate Change and the Environment at the London School of Economics, raises precisely this question. The conclusion is quite simple: burning known reserves of fossil fuels is incompatible with meeting the climate targets governments have set themselves. This being so, prudent investors should apply a discount to both the value of those reserves and returns on new investments in this sector. It is possible that much of this additional spending would prove fruitless. At worst, these assets might be “stranded” forever. In 2010, governments agreed that emissions should be kept at a level intended to prevent an increase in global average temperatures of more than 2C above pre-industrial levels. Using standard models, the report concludes that total emissions of carbon dioxide between 2013 and 2050 needed to deliver that outcome, at 80 per cent probability, would be 900 gigatonnes (billion tonnes) and 1,075 gigatonnes, even at 50 per cent probability. Then, between 2050 and 2100, emissions could be a further 75 gigatonnes, to stay below the 2C ceiling at 80 per cent probability, and 475 gigatonnes, to stay below it at 50 per cent probability. Carbon capture and storage would help, but not that much. Removing an annual flow of 8 gigatonnes of carbon dioxide in 2050 would require close to 3,800 such plants. Even so, unabated emissions must fall sharply. (See charts.)

According to the World Energy Outlook 2012, existing reserves of fossil fuels would, if burnt without capture of the carbon dioxide emissions, release 2,860 gigatonnes – roughly three times the global carbon budget. Burning this stock, without any further additions to it, would push the global average temperature up by well over 3C.

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So what might this mean for the companies listed on the stock exchanges of the world? These hold reserves equivalent to 762 gigatonnes of emissions – about a quarter of the total, the rest being owned by non-listed entities, principally national oil companies. Listed companies are also seeking to develop potential reserves, to bring their total to over 1,500 gigatonnes. On its own the latter sum would exceed the limits on emissions until 2050 needed to keep the average temperature increase below 3C at a mere 50 per cent probability: thus there would be a 50 per cent chance that the rise would be greater. But listed companies would not be on their own: national companies would produce, too.

If instead the listed companies were allocated a quarter of the world’s carbon budget, in line with their share in global reserves, they could not exploit more than a third of their existing reserves of 762 gigatonnes, let alone any additional discoveries if the temperature rise is to be kept below 2C. Even going to a 3C limit would not help much. The listed companies could still not exploit even half of their reserves under that more generous ceiling. Something then will have to give: either the world will abandon its pledge to keep emissions below the level thought to produce a temperature rise of 2C or the fossil fuel companies are holding stranded assets and investing in unusable ones. Investors are implicitly betting on the former possibility. Humanity is making risky bets in the climate casino – ExxonMobil will probably be proved right The oil companies are well aware of this issue. In its response to critics, ExxonMobil says that it does not envisage a low-carbon scenario of the kind many climate researchers advocate. The company believes that the costs this would entail, and “the damaging impact to accessible, reliable and affordable energy resulting from the policy changes . . . are beyond those that societies, especially the world’s poorest and most vulnerable, would be willing to bear”. Instead, the company envisages only that the flow of emissions will stop increasing some time around 2030. But it does not give projections of concentrations of greenhouse gases in the atmosphere. It also does not address temperature effects of those concentrations. The explanation ExxonMobil gives for its optimism about demand for fossil fuels is the rising world demand for energy and the inertia in the global energy system. Even though renewable energy production will grow at a faster rate than other sources, its 285

potential is limited by challenges of “scalability, geographic dispersion, intermittency (in the case of solar and wind), and cost relative to other sources”. The company expects that renewables will comprise only about 5 per cent of the energy mix by 2040.

The world has got itself into an extremely contradictory place. Governments have committed themselves to a view of the risks of climate change. That view implies a rapid revolution in the energy mix and correspondingly rapid reductions in emissions of greenhouse gases. But major energy producers do not believe governments will do what they promise. They envisage a very different and quite unrevolutionary energy future in which the reserves they now possess and those they plan to develop will all be burnt. Investors have to guess not just who is more likely to be right, but what probabilities to put on the possible outcomes. I believe humanity is making risky bets in the climate casino. I think it is likely that humanity will continue to make these risky bets. In that case ExxonMobil will be proved right. But it is always possible that humanity will wake up and make the needed investments in rapid change, driven by the magic of the market and technological innovation. If that happened, fossil fuel reserves would indeed be stranded. Investors beware: the risk of that cannot be zero. http://www.ft.com/intl/cms/s/0/5a2356a4-f58e-11e3-afd3- 00144feabdc0.html#axzz34z7X5JC1

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ft.com Comment Opinion June 16, 2014 4:00 pm The paradox of China’s push to build a global currency By James Kynge Acceptance into global free markets needs liberalisation, writes James Kynge

©Getty We hate you guys.” This was how Luo Ping, a senior official at the China Banking Regulatory Commission, vented his frustration at the US in 2009. He and others in China believed that, as the US Federal Reserve printed money to resuscitate American demand, the value of China’s vast US Treasury bond holdings would plunge along with the dollar. “Once you start issuing $1tn-$2tn . . . we know the dollar is going to depreciate so we hate you guys – but there is nothing much we can do,” Mr Luo told a New York audience. More ON THIS STORY// China bourse approves landmark ABS deal/ Renminbi rise masks fears of deeper woes/ Cross-border China shares closer to parity/ China opens big window to equity market/ Hong Kong and Shanghai to link bourses ON THIS TOPIC// Markets Insight Reasons to be bearish on Chinese banks/ China’s internet troika sweeps up rivals/ China seeks closure to Walmart labour row/ Metal financing fears spread to Singapore IN OPINION// Clearing house chaos/ China will profit from feeding the world’s appetite/ Make shadow banks safe/ Time to focus a light on shadow banking These frustrations have been catalysts of great change. The authoritarian rulers of 1.3bn people felt an imperative to reassert control. Imbued with the resentful narrative of a “century of national humiliation”, they felt the prospect of the US squandering Chinese wealth was an indignity too far. In response, Beijing decided to hasten the promotion of the renminbi as a global currency. That way China’s exporters could earn “redbacks” rather than greenbacks, allowing their revenues to be invested at home rather than recycled into US Treasuries – the only pool of dollar liquidity big and safe enough to absorb significant investments from China’s reserves (which rose to $3.95tn at the end of March). Therefore, the genesis of renminbi internationalisation, which will be a key theme during the UK visit this week of Prime Minister Li Keqiang, is indivisible from China’s 287

aspiration to blaze its own trail rather than integrate into a Pax Americana in whose creation it had no say. The scheme is showing signs of success. Financial capitals are competing for a slice of the fast-growing market in offshore renminbi. London plans to underline its credentials by designating China Construction Bank as a clearing bank for the currency. This should make trading in renminbi more efficient, more liquid and less risky. It could also attract Chinese companies keen to invest in Europe, and make it easier for investors to enter China’s capital markets. The use of renminbi as a global payments currency is growing rapidly, though from a small base. In April it was the seventh most used currency, with 1.4 per cent of transfers, up from 0.6 per cent in January 2013, according to Swift, the international payments company. In the US the redback is also gaining a following, with the value of renminbi payments between the US and the rest of the world rising 327 per cent in April, compared with the value in April 2013. At times, adopting the renminbi is portrayed as a snub to the US. Russian politicians have called for a “de-dollarisation” of their economy after sanctions imposed by the US and EU in response to Moscow’s annexation of Ukraine’s Crimea. Such are the easy wins. Creating a genuine world currency will be much harder, rubbing up against the central paradox of China’s emergence: its political system relies on control while acceptance into global free markets needs liberalisation. Institutions that hold renminbi have precious little scope to invest them. China has opened only tiny apertures for foreign investors in its domestic capital markets, promoting instead an offshore renminbi capital market that is as yet minuscule in comparison with its US dollar counterpart. Jonathan Anderson, economist at the Emerging Advisors Group, estimates that in mid- 2013 total capital market assets freely available to international investors in US dollars were worth $55tn; in euros, $29tn; in yen, $17tn; and, in sterling, $9tn. The renminbi offered a mere $250bn. “That is about 0.1 per cent of the global market, putting the renminbi on a par with the Philippine peso and just a bit higher than the Peruvian nuevo sol,” Mr Anderson wrote. Of course, Beijing could throw open its capital markets but doing so might leave it at the mercy of the type of capital outflow that precipitated the Asian financial crisis in the late 1990s. It would also require the opening up of its state-owned banks, local government bond issuers and state companies to scrutiny from foreign investors. So reasserting one form of control would entail sacrificing another: winning a measure of from the “dollar zone” and the concurrent influence of the Fed would imply inviting in the oversight of global capitalism, the rules of which were written under Pax Americana. http://www.ft.com/intl/cms/s/0/e0146650-f542-11e3-91a8- 00144feabdc0.html#axzz34z7X5JC1

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Daily Morning Newsbriefing June 13, 2014 Renzi’s political crisis and the consequences We are not sure whether this political crisis is as serious as it appears to be, but it is at the very least an example of the fragility of Matteo Renzi’s majority in Italy – and his ability to pass serious reforms. The Partito Democratico replaced one of its dissident Senators, Corradino Mineo, in the constitutional affairs committee, in order to guarantee the passage of its important Senate reforms. That action yesterdays triggered the mass withdrawal of 13 of the PD’s 107 Senators from the group in protest, accusing the party leadership of violating the constitutional right for Senators to speak freely. This in turn led to a furious response by Renzi, who is currently visiting China, saying that he is not going to allow 14 Senators override the will of 41% of voters who had just endorsed his reforms. A party was not a taxi one takes to get elected. Corriere also writes that Renzi said he would not Mineo to keep the peace. While there was talk about a New Centre-Left in opposition to Renzi, it did not seem that the dissidends were about to form their own rival group yet. So this standoff may ultimately be resolved one way or the other. The problem is that it will become much more difficult for Renzi to get the majority in the Senate for his reforms. There was already a reminder of the fragility of his majoirty when the Senate approved some amendment to his justice reforms, by a Senator from the Five Star Movement. Renzi erstwhile opponets, including Stefano Fassina, a previous deputy economics minister, and others call the tactic of the Senate leadership a political mistake. Italy is no stranger to political tempests that dissolve as quickly as they form – which makes it all the harder to gauge the significance of a quickly forming political crisis. While the outcome of this episode unclear, it is certainly a reminder that we should not take the reform agenda for granted, since his majority in the Senate is thin and since there exists a formidable opposition to him inside the PD. The political reforms are critical because he will need clear cut majorities to push through unpopular economic reforms. We have previously observed that a number of unlikely events will have to happen for Italy’s position in the euroone to be sustainable. One of them is a return of eurozone inflation to 2%. Another is a return of average growth to 1% (which is almost as high as Germany’s structural growth rate). A third one is a commitment to fiscal consolidation, but done in a way that does not conflict with the goal of an average 3% nominal growth. There are now signficant doubts about each one of those pre- conditions. Doubts on Spain's deposit guarantee fund We reported yesterday on the annual accounts of Spain’s deposit insurance fund FGD showing a return to positive equity after the extraordinary outlays of the banking crisis

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left it with negative equity at the end of 2013. However, El Confidencial has looked at the auditor’s report filed by PwC and found qualifying statements implying the FGD’s solvency is the result of accounting artifacts. The negative equity of €1.6bn at the end of 2013 was made up by a regular contribution of €1.6bn from the commercial banks in February, which was then augmented by €1.4bn in receivables from an extraordinary levy to be made for the next 7 years, but of which only the first instalment of €234m was actually paid in January. In addition, PwC observes that the FGD is valuing its stake in Catalunya Bank at €824m based on the latter’s 2013 accounts, with no estimate of the likely sale price of the bank when it is finally auctioned off. El Confidencial recalls that the FGD realised a loss of over €500m when it sold NCG for less than 1/3 of its book value. Portugal decides to forego final loan tranche Portugal's finance minister confirmed that it will forgo the final €2.6bn tranche of its international bailout loan because it can't meet its creditors' deadline to present a replacement for the measures ruled unconstitutional by the Court. Alternative measures had to be submitted by the end of this month for the 12th review to end successfully and for the release of the tranche. Or, Portugal asked for an extension of the programme, which the IMF was not very keen on, Diario Economico reports. Maria Luís Albuquerque defended the move two pending court rulings on budget measures. And it would strengthen the government’s credibility and determination to meet budget deficit goals, Reuters quotes her as saying. Albuquerque told the press that Portugal doesn't need the money and that the government has sufficient cash reserves and can continue raising money in the financial markets. As we reported yesterday, it means that Portugal will have to raise more money on the markets if they want to keep their objective to pre-finance two third of the 2015 budget. The 'troika' of lenders said in a statement they "took note" of Lisbon's decision not to complete the final review of the bailout. Wolfgang Schaeuble said the decision by Portugal showed its bailout programme had worked, though according to Diario Economico, there is frustration behind the scenes in the Commission and the IMF over Portugal's decision. The article also notes that the decision does not relieve the government to find alternative measures. Also technically, even if the 12th review was never closed, it will have to be reopened again, once the new measures are known. Irish rents up 9% in May In Ireland, the cost of renting a home rose more than 20 times faster than the average level of inflation over the last year, according to the Irish Times. The data show that private rents were 9% higher in May than a year earlier, while average prices across the economy as a whole rose by just 0.4%. The climbing rents came as the cost of mortgage interest fell by 9.4% on the back of repeated rate cuts from the ECB. This could mean, in theory at least, that a landlord has seen his or her mortgage costs reduce by close to 10% at a time where rental income before tax has climbed by almost the same measure. The IMF report showed that Irish house prices were 10% above their long-run average in relation to rents and 7% below their long-run average in relation to incomes. Russian sanctions are happening – through the backdoor Frankfurter Allgemeine has a very interesting article on Russian sanctions – saying that they are happening through the backdoor. The German government has resisted official 290

sanctions against Russia, but is pursuing a de facto trade embargo by putting on ice applications companies have to file to sell technical equipment to Russia. German engineering companies are complaining that plant and machinery that has already been produced cannot be exported by the approval is not granted. Their association VDMA said 60 such applications have been put on ice, or were rejected. These exports relate to machinery used for civil purpose, but with technology that could have military applications, and thus requires official approval. Good news on industrial production If the ECB has been right on one thing – it has not been inflation, but GDP growth. The ECB’s forecast of a slow and fragile recovery has been spot on, and all the data we are seeing is consistent with that scenario. Yesterday, there was some good news from Eurostat, a month-on-month growth in industrial production of 0.8% in April, after a 0.4% drop in March. Those IP data are notoriously volatile, and once you smooth them out, they are again consistent with the ECB’s scenario. The eurozone is indeed recovering steadily after the recession, but this recovery is slow, and very different from the kind of cyclical recoveries we experienced previously. On an annual basis, industrial output was 1.4% high in April, which would suggest a solid performance, but the March-to-March comparison was only 0.2%. Some analysts suggested that these data may point towards an acceleration in growth in Q2 after the disappointing figures in Q1. There are some signs of weakening growth in Germany though. Flight out of ECB deposits has started Bloomberg reports that cash deposited overnight with the ECB has fallen by €25bn to €13.6bn as a result of the introduction of a negative deposit rate. Commerzbank, for example, announced that it will no longer deposit surplus cash at the ECB. The interest rate decisions had their desired effect on the money markets, with Eonia now trading at 0.04% (see out table below) - just above zero. They yield on German two-year bond dropped to 0.03%. Ralph Atkins warns in the FT that one should not take solace from the extremely low bond yields. It is wrong to think that Spanish debt is safer than US debt. He said the reason why bond yields are falling is the fall in inflation expectations. The biggest risk would be a snapback as the financial market equilibrium is extremely fragile. That sinking feeling – Hollande edition The French president hits new records in unpopularity, with only 15% of the French having a positive view on Francois Hollande according to the YouGov poll for the Huffington Post (via Le Point). Also his prime minister loses momentum, garnering only 30% of favourable opinions, 3pp down compared to last month. Only 16% have a positive view on the government's actions, while 76% have a negative view. The poll also showed that the conservative UMP suffered under the Bygmalion affair, losing 5pp down to 26% favourable opinions. On debt deleveraging Moritz Kraemer of S&P has an excellent analysis on debt deleveraging, which explains in detail of why debt deleveraging in the eurozone is so hard, and that most of the adjustment has yet to happen, and will constrain domestic demand for many years. He notes that the return to current account balance was achieved largely through drops in private and public investment. The metric he applies in his analysis is not the crude 291

debt-to-GDP ratio, but net external debt as a share of current account receipts, and he finds that among 129 sovereigns rated by S&P, half of the sovereigns in the worst 20 were eurozone countries. Here is the punchline: “We believe that in light of their high debt levels, many individuals, companies, and all governments will continue to aim for further balance sheet repair. The contraction of private sector credit in the periphery is in our view at least partly due to flagging credit demand as the cost of debt is considered to be still too high by many periphery corporations and households. In macroeconomic terms this means that savings rates will remain high in the private sector until the desired lower leverage level is reached.” Eurozone Financial Data 10y spreads

Previous This Yesterday day Morning France 0.359 0.371 0.366 Italy 1.402 1.445 1.427 Spain 1.254 1.323 1.310 Portugal 1.962 1.986 1.999 Greece 4.340 4.370 4.36 Ireland 1.030 1.037 1.024 Belgium 0.466 0.487 0.483 Bund Yield 1.395 1.386 1.404

exchange rates

This Previous morning Dollar 1.353 1.3566

Yen 138.040 138.34

Pound 0.803 0.7991

Swiss Franc 1.218 1.2174

ZC Inflation Swaps previous last close

1 yr 0.79 0.79

2 yr 0.88 0.88

5 yr 1.24 1.24

10 yr 1.66 1.66

Eonia

12-Jun-14 0.04

11-Jun-14 0.06

10-Jun-14 0.07

09-Jun-14 0.05

292

OIS yield curve

1W 0.044 15M 0.046 2W 0.060 18M 0.051 3W 0.046 21M 0.062 1M 0.043 2Y 0.070 2M 0.076 3Y 0.140 3M 0.079 4Y 0.268 4M 0.075 5Y 0.428 5M 0.070 6Y 0.611 6M 0.066 7Y 0.798 7M 0.056 8Y 0.977 8M 0.055 9Y 1.141 9M 0.054 10Y 1.288 10M 0.053 15Y 1.802 11M 0.053 20Y 2.029 1Y 0.053 30Y 2.156

Euribor-OIS Spread previous last close

1 Week 2.429 2.429

1 Month 7.957 7.857

3 Months 13.686 15.886

1 Year 40.686 41.586

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-06- 13.html?cHash=d6c46d41375c6ed3ce1f311b263eb8ca

Cash Deposited at ECB Plunges as Negative Rate Starts By Alessandro Speciale - Jun 12, 2014 Cash deposited overnight with the European Central Bank plunged to the lowest level since 2011 as a negative interest rate took effect. Euro-area banks parked 13.6 billion euros ($18.4 billion) in the deposit facility yesterday, down 25 billion euros from the previous day. The ECB has started charging 0.1 percent for holding cash in excess of minimum reserves, making it the first major central bank to do so. ECB President Mario Draghi is fighting a prolonged period of low inflation that threatens to derail the 18-nation currency bloc’s fragile economic recovery. His package of measures announced last week also included cutting all key rates to record lows and offering long-term loans to banks conditional on them lending the money to companies and households. Commerzbank AG, Germany’s second-biggest bank, will no longer deposit surplus cash at the ECB, Chief Executive OfficerMartin Blessing said on June 10. The ECB’s measures have helped push down money-market rates. The cost of overnight unsecured interbank lending, or Eonia, fell to 0.06 percent yesterday, compared with an average of 0.248 percent last month. The yield on the German two-year bond dropped to 0.03 percent today, the lowest level in more than a year. The euro was little changed at $1.3526 at 12:43 p.m. Frankfurt time. The currency closed yesterday at the lowest level since February. // http://www.bloomberg.com/news/print/2014-06-12/cash-deposited-at-ecb-plunges-after- negative-rate-takes-effect.html

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Standard & Poor’s Capital IQ McGraw Hill FinancialFinancial Services LLC The Long Haul: Eurozone Deleveraging Could Stunt Growth For Years 10-Jun-2014 • The Debt Dilemma Facing Periphery Countries The Long Haul Is Just Beginning Government Support Spurred Deleveraging By Banks In The Periphery Weak Growth And Political Polarization Could Ensue As Balance Sheet Repair Continues Notes Standard & Poor's Ratings Services has long held the view that the eurozone's debt crisis originated in the rapid swings in balance of payments following the introduction of the European Economic and Monetary Union (EMU) in 1999. At the time, the adoption of the euro prompted a significant decline in real interest rates in many eurozone countries, reinforced by accommodative monetary conditions in the aftermath of the dotcom bubble and the Sept. 11, 2001 terrorist attacks (see "Who Will Solve The Debt Crisis", Nov. 10, 2011). The introduction of the common currency also led to the disappearance of redenomination risk. This confluence of factors encouraged unprecedented capital flows from countries with a savings surplus (often referred to as the eurozone "core") to those with a savings deficit (the so- called "periphery"). Everything changed in 2008 when, following the collapse of Lehman Brothers on September 15, the intensifying global financial crisis first brought cross-border capital flows to a stop, and then pushed them into reverse. In Europe, the flow reversal accelerated following the recognition on Oct. 16, 2009 by the newly elected Greek government of Georges Papandreou that the national budget deficits had actually been over three times as large as had previously been notified to the European Commission. As the implications of the revelation became apparent to investors, debtors in deficit countries faced a sudden reversal of credit conditions. Overview • Overall leverage in the eurozone periphery, encompassing the public and private sectors, is still near all time highs in absolute terms and as a share of GDP. • The leverage ratio (as a share of GDP) in Greece, Spain, and Portugal was about twice as high in 2013 than it was upon adoption of the euro in 1999, while in Italy it was 35 percentage points higher. The increase in Germany was 4 percentage points over the same period. • We believe that endeavors to reduce the persistent debt overhang will stunt domestic demand in the periphery and thus growth prospects for many years. Although in Greece and Italy the largest debtor was the government, this was not true in most other countries in the periphery. In fact, in the period before the crisis, sovereign debt had declined in Ireland, Slovenia, and Spain. But the very rapid accumulation of private sector debt and the sometimes associated property bubbles in certain periphery countries led to vulnerabilities to external shocks. When the cycle turned, debt levels turned out to be unsustainable for many households and corporates, asset prices dropped, nonperforming loans surged and banking crises ensued. In general, the observed and ongoing rise in government debt was the consequence of the crisis and the ensuing deep recession rather than its root cause. 294

Rising government debt and deficits, sometimes financed through official loans from the International Monetary Fund and other eurozone governments' financial support programs, have in our view effectively provided a buffer that prevented outright deflationary spirals and an even deeper drop in domestic demand and employment. Of course they have also added to national economies' overall debt burden in the form of rising government borrowing, offsetting the incipient deleveraging, via repayment or default, of private sector debtors. Thus, the debt overhang persists. The Debt Dilemma Facing Periphery Countries Increased savings are a necessary condition to first contain and then eventually reduce the large stock of debt, particularly external debt. Indeed, since the sudden stop of cross border capital flows national savings rates have been rising across the periphery. Furthermore, current account balances have turned positive, not only because of rising saving rates, but also declining public and private investment (see "Cracks Appear In Advanced Economies' Government Infrastructure Spending As Public Finances Weaken", Jan. 14, 2014). On most flow measures, therefore, the situation is clearly improving. Nevertheless, the stock of debt remains at very high levels across many periphery countries. Comparing narrow net external debt as a share of current account receipts--in our view a more effective metric for assessing external debt--for all 129 sovereigns rated by Standard & Poor's, we note that almost half the sovereigns in the top-twenty are eurozone members (Note 1, see also http://www.spratings.com/sri; click on "All countries" and select the "External Balance Sheet" tab). Chart 1 | Download Chart Data

Charts 1 and 2 show, based on ECB data, that the overall private and public sector debt of the three resident sectors (households, nonfinancial corporations, and government) in the periphery 295

countries remains near record highs in both percentage of GDP and absolute terms (Note 2). The high debt-to-GDP ratio has been exacerbated by the decline in nominal GDP across the periphery. And while in most periphery countries modest economic growth has resumed, the extremely low GDP-deflator growth (and in some cases outright deflation) will make continuous deleveraging more complicated. Chart 2 | Download Chart Data

The adjusting periphery economies are thus facing a dilemma between their strengthening competitiveness on the one hand (which necessitates inflation rates below the EMU average) and deleveraging (which would be supported by rising price levels). We believe that in light of their high debt levels, many individuals, companies, and all governments will continue to aim for further balance sheet repair. The contraction of private sector credit in the periphery is in our view at least partly due to flagging credit demand as the cost of debt is considered to be still too high by many periphery corporations and households. In macroeconomic terms this means that savings rates will remain high in the private sector until the desired lower leverage level is reached. The corollary of elevated private savings rates is lower levels of consumption and investment. Domestic demand in the periphery is being further curtailed by fiscal consolidation, as governments attempt to make good on their commitments to reduce their fiscal imbalances through a combination of tax increases and spending cuts. Consequently, we expect that all components of domestic demand (private consumption, private investment, and government spending) will remain under pressure. This will likely place added importance on export performance and further external rebalancing to generate the sustained economic growth rates required to improve still depressed economic and employment conditions (see: "The Eurozone's Long, Unwinding Road", Dec. 3, 2013).

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The Long Haul Is Just Beginning What constitutes the appropriate leverage level in an economy depends on a multitude of factors, including interest rates, debt structure, assets owned by debtors, economic conditions, demography, and many more. The length of this list indicates that there is no simple answer to establish where the new debt equilibrium might lie for individual periphery sovereigns. By extension it also suggests that it may be difficult to assess how much longer the demand- and growth-depressing deleveraging might last. However, we believe that it is reasonable to assume that the longest stretch of public and private deleveraging still lies ahead in most periphery economies. Indeed, for the public sector, debt levels are continuing to rise and the deleveraging process has not yet begun. Table 1 shows that for selected eurozone economies, private sector debt at the end of 2013 is down from its peak, but typically by only relatively small amounts. As an indication of the rate of deleveraging, we have calculated a debt reversal ratio for each country based on the drop in debt/GDP from its peak until 2013Q4 as a percentage of the increase in debt/GDP leading up to this peak from 1999Q1. For example, as a share of concurrent GDP, the Spanish corporate sector has reduced its debt ratio by a quarter of the increase that had occurred between the introduction of the euro and the peak. Spanish households, meanwhile, have worked down a quarter of the debt ratio increase since 1999. By that measure Ireland's private sector has also been able to reduce its debt more than its peers in the periphery, albeit from a much higher level than most. In Portugal, where private sector debt ratios also remain high, much less progress has been achieved, especially in the corporate sector. It is no coincidence that to date Spain and Ireland have been the only periphery sovereigns upgraded by Standard & Poor's (other than Greece and Cyprus after their respective defaults), even if their respective ratings remain at least two categories (or six notches) below their pre- crisis peaks. In the same vein we have also taken positive rating actions on several Spanish banks (see "Various Rating Actions Taken On Spanish Banks Following Recent Sovereign Upgrade And More Favorable Economic Prospects", June 7, 2014). Nevertheless, since public sector debt has continued to rise across the periphery and remains at peak levels despite the unprecedented fiscal efforts of some governments, as a general matter deleveraging appears to have barely begun. Table 1 | Download Table Moderate Progress Of Macroeconomic Deleveraging From Debt Peak (By Institutional Sector, % Of GDP) Debt ratio Peak 1999Q1 Peak Change peak reversal rate quarter to peak* ratio to 2013Q4 § (%)

Portugal Total 2013Q2 192.1 380.8 (7.1) (3.7) Corporate 2013Q2 52.5 137.1 (3.5) (6.7) Household 2009Q4 49.7 95.4 (8.5) (17.1) Public sector 2013Q2 95.2 153.6 (0.4) (0.4)

Spain Total 2013Q4 154.2 307.7 0.0 0.0 Corporate 2010Q2 81.0 128.1 (20.4) (25.2) Household 2010Q2 50.1 87.5 (10.3) (20.6) Public sector 2013Q4 54.0 122.9 0.0 0.0

Italy Total 2013Q4 71.6 275.9 0.0 0.0 Corporate 2009Q2 36.9 90.6 (5.3) (14.4)

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Household 2011Q2 26.0 45.5 (0.7) (2.7) Public sector 2013Q4 14.8 146.0 0.0 0.0

Greece Total 2013Q4 148.8 304.2 0.0 0.0 Corporate 2009Q3 33.6 70.3 (5.5) (16.4) Household 2013Q4 55.1 64.5 0.0 0.0 Public sector 2013Q4 65.6 175.0 0.0 0.0

Ireland Total 2013Q1 231.8 437.4 (9.1) (3.9) Corporate 2012Q3 87.6 204.4 (13.6) (15.5) Household 2009Q4 72.1 125.1 (23.8) (33.0) Public sector 2013Q4 100.3 136.1 0.0 0.0

Slovenia Total 2013Q2 91.3 185.2 (1.3) (1.4) Corporate 2010Q1 39.6 88.1 (13.9) (35.1) Household 2010Q4 15.2 31.0 (1.4) (9.2) Public sector 2013Q4 50.5 80.1 0.0 0.0

Germany Total 2010Q4 16.0 206.1 (7.9) (49.4) Corporate 2003Q2 9.3 64.7 (6.9) (74.2) Household 2000Q4 3.0 73.3 (16.2) (540.0) Public sector 2012Q2 25.4 89.7 (6.5) (25.6)

France Total 2012Q1 93.2 248.2 (2.0) (2.1) Corporate 2012Q3 31.7 84.6 (2.4) (7.6) Household 2013Q4 23.7 57.3 0.0 0.0 Public sector 2013Q1 39.2 107.7 (1.0) (2.6)

*Ireland from 2002Q1 and Slovenia from 2004Q1 to peak, respectively. §Debt/GDP decline from peak to 2013Q4 as a percentage of debt/GDP increase from 1999Q1 to peak. Source: European Central Bank, Standard & Poor's.

Table 2 simulates the potential future trajectory of the deleveraging process for the private sector (households and corporates). In this simulation we assume that from 2014Q1 onwards the quarterly change in the private sector debt-to-GDP ratio changes at the same linear rate (in absolute percentage points of GDP) as the average quarterly change between 2012Q4 and 2013Q4. Under this extrapolation the (unweighted) average private-sector debt ratio of the six periphery economies would by 2020 have fallen back to 134% of GDP, a level last observed in 2005, from the 2011 peak of 187% of GDP (see last column). In this simulation, deleveraging in Spain would advance the furthest: the private sector debt ratio would reach 2001 levels, while Portugal, Ireland, and Slovenia would return to debt ratios last observed in 2004 to 2005. In Greece, deleveraging would proceed at the slowest rate with an almost unchanged debt ratio. By 2020, Portugal and Ireland would still have the highest private leverage ratios, while Italy's and Slovenia's private sector would continue to be the least indebted relative to GDP. We stress that this is just one possible outcome. Depending on the data and the methodology used to assume a new equilibrium point, the projected pace and end of the deleveraging process could be different. Decisions by economic agents on the desired pace of whittling down the debt, as well as possible changes in average nominal GDP growth will influence the speed of deleveraging. A recovery of economic activity and the GDP deflator growth could lead to a faster reduction in the debt burden of households and companies across the periphery.

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Chart 3 shows by how much the overall leverage (as a share of GDP) has increased since the adoption of the euro and since the beginning of 2006 through December 2013 (the last quarter for which the ECB is currently showing comparable cross-country data), and by how much (or little) the overall leverage ratio has come down from the respective peaks. Of course the leverage level prevailing at the time of the euro introduction is a somewhat arbitrary benchmark. It could be argued that the sustainable level of debt is now higher than it was pre EMU. The disappearance of redenomination risk since the inception of the EMU and the high credibility that the ECB enjoys (compared to some of its national predecessors) could, for example, contribute to a higher tolerance for debt among economic agents in the periphery compared to pre-1999. Table 2 | Download Table

Simulation of Private Sector Debt Developments in The Periphery (% of GDP, year-end data) Portugal Spain Italy Greece Ireland Slovenia Unweighted Average 2020 178.0 109.5 109.1 128.5 197.6 79.1 133.6 2019 184.0 120.3 112.0 128.6 211.1 82.7 139.8 2018 190.1 131.0 115.0 128.7 224.6 86.2 145.9 2017 196.1 141.8 118.0 128.8 238.1 89.7 152.1 2016 202.2 152.6 121.0 128.9 251.6 93.2 158.3 2015 208.3 163.3 124.0 129.0 265.1 96.7 164.4 2014 214.3 174.1 127.0 129.2 278.6 100.3 170.6 2013 220.4 184.8 130.0 129.3 292.2 103.8 176.7 2012 226.5 195.6 133.0 129.4 305.7 114.3 184.1 2011 225.0 206.7 132.5 129.2 311.2 116.0 186.8 2010 224.8 214.1 133.3 127.6 298.4 118.3 186.1 2009 225.7 213.4 132.4 122.5 303.1 116.2 185.5 2008 217.2 205.8 125.8 118.4 272.4 107.8 174.6 2007 204.3 200.2 121.7 106.6 230.0 98.2 160.2 2006 193.4 184.9 114.7 97.4 215.0 84.1 148.2 2005 185.7 161.2 107.9 89.3 204.7 78.0 137.8 2004 177.8 143.3 101.7 77.8 189.1 68.7 126.4 2003 178.3 132.0 97.4 71.2 173.9 2002 171.9 121.5 93.3 67.2 167.6 2001 168.6 114.9 89.9 63.0 2000 156.9 107.5 85.9 54.8 1999 146.3 98.5 82.1 50.4 The trends in private and public debt to GDP are largely mirrored in banks' balance sheets (see Chart 4). In the eurozone, aggregated total banking assets to GDP soared to 356% in 2011 from 247% in 1999. This ratio has since fallen back to 318% in 2013 (see Table 3). In other words, 35% of the increase in banks' assets (as a share of GDP) between 1999 and the 2011 peak has already been reversed. For the six periphery economies this reversal was on average lower at one-fifth, spanning from around 10% in Italy, Slovenia, and Greece to 58% in Ireland. Even so, Ireland's banking system is still by far the largest relative to the size of its economy, which largely reflects off-shore banking operations driven by Ireland´s favorable tax legislation. With

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banking assets at 620% of GDP, Ireland's are twice as large as those of Portugal and Spain, which have the second and third biggest banking systems relative to GDP, respectively. Chart 3 | Download Chart Data

Government Support Spurred Deleveraging By Banks In The Periphery Table 3 | Download Table Total Banking Assets As A Percentage Of GDP Change Change 1999 Q1 Peak Year Banking assets Peak year To peak year* Peak ratio to 2013 reversal rate (%) Portugal 2012 127.3 337.4 (26.5) (20.8) Spain 2012 168.1 348.0 (39.9) (23.8) Italy 2012 124.6 269.4 (9.9) (7.9) Greece 2010 78.1 231.8 (8.0) (10.3) Ireland 2009 672.9 1006.9 (387.0) (57.5) Slovenia* 2009 150.8 150.8 (19.4) (12.8) Germany 2010 49.0 332.9 (57.8) (118.1) France 2011 154.3 419.6 (37.0) (24.0) Euro area§ 2011 108.7 355.8 (37.9) (34.9)

*Data for Slovenia since 2004 only. §Changing composition. Source: European Central Bank,

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Eurostat, Standard & Poor's.

Chart 4 | Download Chart Data

We believe that most of the relatively faster decline in the size of banks' balance sheets from their peaks relative to the reduction in overall leverage in the periphery can be explained by two key factors. First, governments' share of overall national leverage is increasing. Governments tend not to borrow directly from banks, but to issue capital market instruments of which only a part will become bank assets (even as banks in the periphery have increased their exposure to government bonds, see "While Banking Union Proceeds, Sovereign And Bank Risks In The Eurozone Remain Intertwined", March 10, 2014). In addition, several governments have provided state aid to distressed banks, which either allowed banks to write off assets or transfer bad assets to the government thus increasing general government debt burdens. The second factor lies in corporate funding strategies that in many cases appear to have substituted bank lending with capital market issuance. Both factors have led to a relatively faster decline in bank assets than overall national leverages. Weak Growth And Political Polarization Could Ensue As Balance Sheet Repair Continues In our view, the sheer scale of the ramp-up in debt ratios in many periphery nations even from 2006 levels and the relatively minor reversal since the peak strongly suggest that the deleveraging process has only just begun. While for Portugal, Spain, Greece, Italy, Ireland, and Slovenia, debt as a share of GDP increased by an average 106 percentage points of GDP between early 2006 and the peak quarter in 2013, the ratio has decreased by only 3 percentage points of GDP from that peak. The disparity between these two figures signals in our view the slow progress that has been made in the periphery in bringing down combined private and

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public leverage, even assuming nominal GDP growth (the denominator in this equation) will perform better in the future than it has since 2006. Accordingly, we expect that the already fragile economic recovery in the eurozone is likely to remain subdued. Moreover, if recovery expectations disappoint, we think this could exacerbate political polarization and thus pose an increasing threat to sustaining growth- enhancing, but often unpopular, reforms. We have observed rising public discontent, most recently evidenced by many voters opting for Eurosceptic parties in the May 2014 European parliamentary elections. Without a swifter economic recovery and growth in employment, we think popular dissatisfaction could swell. Ultimately, though, growth will remain dependent on net export performance, as domestic demand will face continuous headwinds. Our sovereign ratings therefore reflect our cautious view on the eurozone's growth prospects over the medium term. Notes 1. These are Luxembourg, Greece, Portugal, Italy, Cyprus, France, Spain, Ireland, Finland and The Netherlands. 2. All data used in this article, unless otherwise noted, is from ECB, Quarterly Euro Area Accounts Debt (loans, debt securities and pension fund reserves). Where the information is available, we have used partially consolidated nonfinancial corporations' debt. Where the series is unavailable (Italy 1999Q1 through 2005Q3, France 1999Q1 through 2005Q4, and Ireland 2002Q1 through 2005Q4) we retrofitted the last available partially consolidated observation with the quarter-on-quarter growth rates of the unconsolidated nonfinancial corporation debt amounts where they reach back further. The definition of debt includes loans, securities, and pension fund reserves. Where debt is expressed as a percentage of GDP, it is as a share of the sum of the four trailing quarters nominal GDP as reported by Eurostat. Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook

Primary Credit Analyst: Moritz Kraemer, Frankfurt (49) 69-33-999-249; [email protected]

Secondary Contact: Stefan Best, Frankfurt (49) 69-33-999-154; [email protected]

Research Contributor: Liliana Negrila, Frankfurt +49 69 33 999-248; [email protected] https://www.globalcreditportal.com/ratingsdirect/renderArticle.do?articleId=1330811&SctArtId =242085&from=CM&nsl_code=LIME&sourceObjectId=8648167&sourceRevId=2&fee_ind=N &exp_date=20240609-17:42:03

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ft. com World Europe June 12, 2014 11:58 pm Cameron appeals for ‘courage’ in opposition to Juncker By George Parker, Political Editor David Cameron pleads with other European leaders on Friday to “have the courage of their convictions” by standing up against the appointment of Jean-Claude Juncker as president of the European Commission. The prime minister, writing in a number of European newspapers, argues that many leaders have deep misgivings about “a power grab through the backdoor” by the European Parliament, which is demanding that Mr Juncker be given the top EU job. More ON THIS STORY// Cameron’s allies align with Merkel’s foes/Global Insight Cameron plots risky course/City of London rues departure of EU influence/Cameron adds new Brussels chief to Merkel’s lunch menu/Leadership battle grips EU amid poll shock ON THIS TOPIC//Tory backbencher to try and force referendum/Editorial Cameron’s flawed tactics on Europe/Martin Wolf UK has to be in or out of EU/Tory anti-euro alliance angers Merkel IN EUROPE//Kiev accuses Russia over tanks in east/Q&A Brussels tax probe/Platini withdraws support for Blatter/Berlusconi’s party faces financial crisis He dismisses the claim by the parliament that the former Luxembourg prime minister, as the lead candidate of the dominant centre-right EPP group, should have an automatic right to the commission presidency. “Those who voted did so to choose their MEP, not the commission president,” Mr Cameron said. “Mr Juncker did not stand anywhere and was not elected by anyone. “To accept such a claim would be deeply damaging for Europe and would undermine, rather than strengthen, the EU’s democratic legitimacy.” Mr Cameron says that while Mr Juncker is “an experienced European politician”, he was not a candidate “who will convince Europe’s voters we are acting upon their concerns”. The prime minister’s stance against Mr Juncker has been criticised by many MEPs and Angela Merkel, German chancellor, has rebuked him for his “threat” that Britons might be more likely to vote to leave the EU if the Luxembourger was in charge in Brussels. But Mr Cameron writes: “Britain has a reputation for standing up for democracy and for fighting for our national interest. But this is about fighting for the European interest. And the three major UK parties are united on this issue. “Now is the time for Europe’s national leaders to have the courage of their convictions by standing up for their place in the EU and what is right for Europe’s future. “Now is the time to propose a candidate who will convince Europe’s voters we are acting upon their concern.” http://www.ft.com/intl/cms/s/0/31d1a75e-f256-11e3-ac7a- 00144feabdc0.html#axzz34VU34zfw

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ft. com World Europe Brussels June 12, 2014 6:26 pm Dublin grows jittery over EU probe into ‘sweetheart’ tax deals By Vincent Boland in Dublin

©AFP The governor of California was joking. Or was he? At a breakfast last week in San Francisco, Jerry Brown admitted he was surprised that Apple – about as Californian a company as can be imagined – turned out to be Irish, after all. “I don’t know how you got Apple to have so much of their business in Ireland,” Mr Brown told an audience that included Enda Kenny, the Irish prime minister. “We thought they were a California company but when you look at their tax return, they are really an Irish company. Anyway, that is part of the creativity – yeah, it’s called creative accounting. Anyway, I won’t go there.” More ON THIS TOPIC/Fast FT Brussels opens tax probe into Apple, Starbucks, Fiat/ Pension funds accused of tax avoidance/ Stars face big tax bill after tribunal ruling/ Luxembourg and Austria back tax plan IN BRUSSELS// Cameron’s allies align with Merkel’s foes/ EU to probe Apple’s Irish tax affairs/ Swedes hit Juncker’s hopes for top EU job/ Juncker refuses to ‘give in’ to Cameron Cue laughter, including from Mr Kenny, according to reports of the event. But they are not laughing in Brussels. The European Commission moved on Wednesday to launch a formal investigation into arrangements between Apple and the Irish tax authorities as part of a probe into “sweetheart” tax deals between some European countries and selected foreign companies. That is making the authorities in Dublin nervous. The government has hired legal big guns in Dublin and London to fight its corner, including if necessary in the European courts. The Irish authorities now find themselves in a fight they never wanted to pick, having to make the case for and defend the integrity of the country’s tax regime in a climate of growing hostility to corporate tax avoidance. Apple matters to Ireland. The US company’s manufacturing and services plant in Cork, established in 1980, employs more than 4,000 people. And Ireland matters to Apple. Cork has become the hub for much of its financial engineering.

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In its 10-k filing with the US Securities and Exchange Commission for the fiscal year to September 2013, Apple says “substantially all” of its undistributed international earnings intended to be “indefinitely reinvested” in operations outside the US were generated by subsidiaries organised in Ireland. Such earnings amounted to a cumulative $54.4bn. Apple says it pays “every euro of every tax that we owe” and adds: “Since the iPhone launched in 2007, our taxes in Ireland have increased tenfold.” An Apple spokesman would not elaborate. Interactive Global tax map

Explore our global tax map and compare rates in key countries around the world Ireland brought its taxation of transfer pricing, the subject of the commission investigation, into line with international practice in 2010, and is also moving from the end of this year to close the “double Irish” loophole, which allows companies to use subsidiaries to channel royalty payments through Ireland to tax havens such as the Caribbean. Ireland’s corporate tax regime, centred on its 12.5 per cent headline rate, is not strictly speaking at issue in the Apple case. But officials fear that it may become a focus at some point given that it has come under attack from other European countries in the wake of the global financial crisis, which led to a €67bn international bailout. The 12.5 per cent tax rate is central to an Irish economic model that is based on attracting foreign direct investment. This has created a flood of FDI over four decades. These companies now employ tens of thousands of people, often in highly skilled jobs such as research and development. Fergal O’Brien, head of policy at Ibec, the employers’ lobby, says Ireland has created a “brand” around its tax competitiveness. “It is rarely the number one issue [in securing FDI] but it is a very important part of the package,” he says. As the Apple case highlights, however, these companies are increasingly using Ireland for tax planning, raising the question of whether tax is, in fact, the number one issue for multinationals considering Ireland. This is a reputational issue for Ireland, experts say. James Stewart, a professor at Trinity College Dublin, says a sustainable economic model cannot be built on tax policy. “The problem with that is that tax policy is out of your control,” he says. “It depends on what the US does, on what France does, on what Germany does. I don’t think you can get long-term economic success that way. It just leads to a huge tax avoidance industry.” http://www.ft.com/intl/cms/s/0/caef5846-f238-11e3-9015- 00144feabdc0.html#axzz34VU34zfw

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ft.com comment Columnists June 12, 2014 6:53 pm No shelter for Britain in European halfway houses

By Martin Wolf Attempts to keep privileged access to EU markets outside the EU would be an added humiliation

©Reuters David Cameron and Angela Merkel The UK is, has been and always will be a European country. The EU remains far and away the UK’s biggest trading partner and London is Europe’s financial capital. What happens inside its European neighbours will always be of vital interest to the UK. Yet the UK’s history has also been different from that of the rest of the continent. Guarded by the sea, it managed to prevent invasion. Seeking to exploit opportunities across the oceans, it devoted itself to keeping Europe out of the hands of a single despotic ruler. It succeeded. Today, the UK is no longer a global power, while Europe is uniting peacefully. Legally, the UK is inside the EU. Psychologically, it is ever more outside it. It is, in brief, semi- detached. This is shown in its rejection of the euro, in the rise of the UK Independence party and in the promise of David Cameron, the prime minister, of a referendum on EU membership in 2017. More ON THIS STORY// Cameron heads for fresh rift with Merkel/ Merkel seeks to dispel fears of Brexit/ Nikolaus Blome Decide on Europe, Mr Cameron/ EU rebels prepare to defy Cameron/ UK ‘would not be freer’ after leaving EU ON THIS TOPIC// Cameron asks for ‘courage’ in opposing Juncker/ Tory backbencher to try and force referendum/ Editorial Cameron’s flawed tactics on Europe/ Cameron’s allies align with Merkel’s foes 306

MARTIN WOLF// Events that shaped our world/ Martin Wolf Another rabbit from the hat/ Business unlocks growth/ Independence is for ever Whether this referendum will happen depends on the outcome of next year’s general election. Ed Miliband, leader of the opposition Labour party, is not committed to a referendum. Yet the question of the UK’s place in Europe will not go away. Gaining full access to EU markets while doing as it pleases is an option the UK cannot have. Its choice is this: more independence and less influence or less independence and more influence. This week, the Centre for European Reform produced a report on the economic consequences of leaving the EU. (I was a member of the commission that produced this report.) Its conclusion is stark: all conceivable halfway houses would deliver the lack of influence that comes from being outside the EU with the lack of independence from being inside it. “In” or “out” is the choice: of the two, the first would be vastly better. The halfway-house alternatives to being inside the EU might include membership of the European Economic Area (like Norway), membership of the customs union (like Turkey) or bilateral agreements (like Switzerland). If the UK were in the EEA, it would retain access to the single market but would have no voice in setting its rules. If the UK were in the customs union, it would lose access to the single market and would have to accept the common external tariff. If the UK sought bilateral agreements it would be at the mercy of a vastly more powerful partner: the UK does 50 per cent of its trade with the rest of the EU, while the latter does 10 per cent of its trade with the UK. It is perfectly possible that a lethal blend of xenophobia, public folly and political incompetence will lead to a UK exit from the EU Again, if the UK wanted any form of privileged access to EU markets it would have to accept EU regulations, the bete noire of eurosceptics. Furthermore, should the UK choose membership of the EEA, it would still be bound by rules on freedom of movement of people. Should it not even be in the EEA, it might regain control over movement of people, but that would depend on the outcome of bilateral negotiations on market access. Even the saving on net budgetary contributions (now 0.5 per cent of gross domestic product) following an exit could be notional. If the UK still wanted access to EU markets on privileged terms it would have to make a fiscal contribution, as do Norway and Switzerland. Today, Norway’s contribution per head is much the same as the UK’s. The only way to give the UK more independence would be abandonment of all forms of privileged access to EU markets and so total reliance on membership of the World Trade Organisation. But that would also give the UK little say in new plurilateral agreements among big powers, provide negligible protection to its exports of financial services, damage its appeal as a base for multinationals’ exports to the EU and allow the eurozone to force relocation of trading in euro-denominated assets from London. Yes, full exit would allow the UK greater freedom over its own regulations. But, as the OECD has shown, product and labour market regulations in the UK are already among the least restrictive in the developed world, despite EU membership. Though some fantasists hope that these rules would be repealed if the UK left the EU, the idea that the British people would allow elimination of almost all labour, product or environmental regulations is mad. Remember: the most economically damaging UK restrictions – those on land use – are, alas, entirely home-grown. 307

It is perfectly possible that a lethal blend of xenophobia, public folly and political incompetence will lead to a UK exit from the EU in the next parliamentary term. But let us be clear about the implications. All attempts to preserve some form of privileged access to EU markets while being outside the EU would merely add humiliation to all the other disadvantages. Full exit would at least be an honest choice. But it would also be extraordinarily stupid. It would bring no important economic benefits, while certainly delivering significant costs. The British people might not like their current position. But it is much the best of all available choices. In any referendum, I would expect them to reach that obviously sensible conclusion. http://www.ft.com/intl/cms/s/0/0813c1ae-f099-11e3-8f3d- 00144feabdc0.html#axzz34VU34zfw

ft.com/markets MARKETS INSIGHT June 12, 2014 8:25 am Grouchy eurozone bonds tell downbeat story By Ralph AtkinsAuthor alerts Historically low yields do not mean crisis has passed for good A lot of fanciful questions have been asked following the latest falls in eurozone government borrowing costs. French 10-year yields have not been lower since at least the War of the Austrian succession in the 1740s, according to Deutsche Bank; Spain’s not since 1789. Are Spanish bonds now really safer than US Treasuries? Will Asian investors quit continental Europe for higher-yielding US or UK bonds? Can we consign the eurozone crisis to the history books? More ON THIS TOPIC// Kenya data revision adds fifth to economy/ Cyprus in first post-bailout public bond/ Markets Insight Rate rises will come despite lower yields/ Europe periphery spreads at 2-month highs MARKETS INSIGHT// Crazy equities should be boring as bonds// Echoes of pre- crisis world grow/ Corporate tax escape trick set to backfire/ Draghi tightens central banks’ grip The answer to all the above is: of course not. Instead, historically low yields, which move inversely with prices, reflect – at least in part – a more depressing story. Southern eurozone debt is behaving again like in normal, grouchy bond markets – with yields falling when economic growth and inflation are low, and central bank action is likely, possibly by buying bonds. Worse, whether yields remain at historic lows will depend on the European Central Bank maintaining investors’ confidence in the eurozone’s stability at a time when its

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problems have switched from acute to chronic. Any slip which perhaps upsets expectations of eventual “quantitative easing” could produce a disruptive correction. Character change The eurozone crisis changed the character of government bonds. Rather than “rates markets”, with yields linked to economic growth and inflation, they became “credit markets” – varying according to default dangers. Yields on Spanish, Italian, Irish, Portuguese and Greek debt reflected market bets on the likelihood of their ejection from Europe’s monetary union. Subsequently, that transformation has been largely reversed. Since Mario Draghi, ECB president, pledged in July 2012, to do “whatever it takes” to save the euro, risk premiums demanded by investors have slumped. Investors have recently focused instead on the threat of deflation. Last week the ECB lowered further its inflation forecasts, and took steps that nudged bond yields even lower. A cut in the central bank’s main policy interest rate, and a negative rate on its deposit facility, pushed overnight market borrowing costs – which act as a benchmark for bonds – to levels scarcely higher than zero. The ECB also announced fresh liquidity providing operations aimed at encouraging banks to lend to businesses. In addition, Mr Draghi pledged that if conditions deteriorated, “we’re not finished” – keeping alive expectations of eventual QE. “It has cemented the fact that funding is not an issue at all,” says Jim Reid, credit strategist at Deutsche Bank. Spanish and Italian 10-year yields dipped this week to just 2.57 per cent and 2.70 per cent respectively. The “spreads”, or difference, over German Bunds dropped to four- year lows. Madrid’s borrowing costs were even lower than for the US, although the comparison is between apples and pears given the currencies are different – as are the US and European growth outlooks. In corporate credit markets, the convergence has been even more remarkable. Investors no longer systematically trash companies in weaker economies. The premium demanded on the debt of periphery eurozone companies with triple-B credit ratings compared with rivals in “core” countries has disappeared, according to calculations by Barclays. Snapback risks Such low borrowing costs should help nurture the eurozone’s nascent economic recovery, securing its longer-term stability. But how long can they last? There are no obvious immediate triggers for a correction. “That previous situation, where Spanish credits get beaten up just because they are Spanish, is unlikely to come back as long as the ECB is supporting the market,” says Zoso Davies, credit strategist at Barclays. In a best-case scenario, bond yields would rise gradually as economies improved and annual eurozone inflation rose back towards the ECB’s “below but close” to 2 per cent target. The risk, however, is of a snapback, or a resurgence in “credit premiums”. One senior European official I spoke to voiced a common view, fretting about “irrational

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exuberance” in the pricing of shorter-dated government bonds. Governments are likely to accelerate debt-raising plans to take advantage of the current lull: Cyprus is currently testing markets; Greece could soon return with a second benchmark bond issue this year. As the ECB noted in its “financial stability review” last month, confidence in eurozone markets “hinges to a large extent on the sustainability of a fragile economic recovery, where risks remain largely on the downside”. Geopolitics and China’s economic vulnerabilities were other threats. The truth is that, in such historically unprecedented times, nobody knows what will happen next. But a lot also hangs on Mr Draghi. http://www.ft.com/intl/cms/s/0/2fa3a11e-f15a-11e3-9fb0- 00144feabdc0.html#axzz34VU34zfw

ft.com Comment Blogs Money Supply Deflation: history lessons Claire Jones Jun 12 17:102Share Throughout its campaign to convince everyone that the eurozone is not about to fall into deflation, the European Central Bank has drawn a distinction between two different sorts of episodes of falling prices. The first involves a short period during which prices fall. In its monthly bulletin, published on Thursday, the ECB tries to define it, not as deflation, but as “negative annual inflation”. In the ECB’s view, a few months of falling prices will do little long- term damage to the economy. Indeed, the eurozone has already experienced this sort of deflation in the autumn of 2009. The more dangerous sort of deflation, which the bulletin labels “outright deflation”, can, however, cause lasting pain. If what Mr Draghi has recently dubbed a “pernicious negative spiral”, triggered by ever weaker demand, was to emerge, all hope of the currency bloc’s economy returning to health anytime soon would be shot. So how can you tell one from the other? In the bulletin, the ECB argues that “outright deflation” is very rare. While there have been several episodes of “negative annual inflation”, since the second world war there have been only two cases of “deflation”: Japan between 1995 and 2013, and Hong Kong between 1999 and 2004. To tell the difference between the two, the ECB places a lot of faith in inflation expectations (the central bank has consistently argued that these remain well-anchored in the eurozone). If expectations were to fall, investors, businesses and households might delay spending on the belief that prices would go further down. Only then would demand really spiral downwards. The central bank is also looking at the proportion of goods and services for which prices are falling. Here is how Japan and Hong Kong fared:

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The IMF has put the chances of falling prices in the eurozone at one in five. But does the ECB need to worry about “outright deflation”? “Not yet,” says the central bank. While the proportion of goods and services in deflation has increased, it remains less than half the level seen in Japan and Hong Kong. There are, however, some reasons for caution. History would suggest economies are especially vulnerable to deflation after financial crises: both the Japanese and Hong Kong episodes were preceded by one. Sounds familiar? The ECB should also be wary of attaching so much importance to inflation expectations: Japan’s experience suggests these don’t tell you much at all. 311

http://blogs.ft.com/money-supply/2014/06/12/deflation-history-lessons/

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Économie : pourquoi la France et l'Allemagne ne peuvent pas s'entendre Le Point.fr- Publié le 13/06/2014 à 10:27 En dépit des discours rassurants, il sera très difficile pour les deux pays de trouver une politique économique et industrielle commune tant ils sont différents.

François Hollande et Angela Merkel.© LIONEL BONAVENTURE / AFP Par PATRICK ARTUS Nous pensons qu'il sera très difficile de parvenir à un consensus sur les politiques économiques à mener dans la zone euro entre la France et l'Allemagne, puisque ces deux pays, pour des raisons fondamentales, profondes, font des choix stratégiques de politique économique différents. D'abord, l'Allemagne est obsédée par le vieillissement démographique. La France, au contraire, a plutôt une stratégie de soutien de la croissance. Par ailleurs, l'industrie allemande a un niveau de gamme élevé et importe beaucoup de composants depuis les pays extérieurs à la zone euro. L'Allemagne est donc favorable à un euro fort. L'industrie française a, au contraire, un niveau de gamme assez faible et importe moins depuis les pays extérieurs à la zone euro. La France est donc favorable à un euro faible. Le problème central de l'Allemagne : payer les retraites L'Allemagne (l'opinion, les décideurs) est extrêmement consciente de son rapide vieillissement démographique : en 2030, les plus de 60 ans représenteront près de 80 %

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de la population active en Allemagne. Le problème central de l'Allemagne est donc d'être capable de payer les retraites avec une population active de plus en plus faible. Pour cela, il faut bien sûr conserver une industrie de grande taille versant des salaires élevés, mais aussi, en ce qui concerne les politiques économiques de l'Allemagne, avoir une inflation faible pour conserver des taux d'intérêt réels à long terme positifs, ce qui accroît le rendement des régimes de retraite et de l'épargne privée. Les taux d'intérêt réels négatifs de 2011-2012 sont défavorables dans une économie d'épargnants : accumuler des actifs et non des dettes, pour pouvoir utiliser ultérieurement ces actifs pour soutenir la consommation des retraités. Cela explique la volonté en Allemagne de réduire le taux d'endettement public avec la règle budgétaire qui impose l'équilibre budgétaire : ne pas privilégier le soutien de la demande intérieure, car une population vieillissante n'a pas besoin de beaucoup consommer ou d'acheter de logements et car, de plus, une demande intérieure forte compromettrait les excédents extérieurs et l'accumulation d'actifs extérieurs. L'Allemagne a aujourd'hui des actifs extérieurs nets représentant plus de 40 % du PIB. L'Allemagne souhaite donc une politique monétaire restrictive (inflation faible, taux d'intérêt réels positifs), une politique budgétaire (réduction de la dette publique) et de la demande (accumulation d'actifs extérieurs) restrictive. La France souhaite conserver des déficits publics La France a, au contraire, une stratégie de retour à la croissance, avec une démographie plus favorable que l'Allemagne (taux de fécondité à 2 contre 1,4). La France souhaite donc, à la différence de l'Allemagne, des taux d'intérêt réels à long terme favorables aux emprunteurs. Elle souhaite conserver des déficits publics, s'ils financent des investissements publics utiles avec des investissements publics en France beaucoup plus élevés qu'en Allemagne (3,14 % du PIB contre 1,5 %), des politiques de soutien de la demande, même si elles déséquilibrent le commerce extérieur. Les Français pensent que ce sont les politiques de soutien à la demande qui entraînent la croissance. Intérêts divergents en ce qui concerne l'euro L'Allemagne a une production industrielle haute en gamme (ce que montre la faible élasticité-prix de ses exportations en volume : 0,2 contre 1,1 en France), ce qui implique que l'appréciation de l'euro réduit très peu (pas du tout ?) les exportations en volume de l'Allemagne, qui ont augmenté plus vite que le commerce mondial depuis la fin des années 1990. De plus, l'Allemagne a délocalisé en dehors de la zone euro une partie importante de la production de composants nécessaires pour son industrie (les importations de ce type de produits sont deux fois plus élevées en Allemagne qu'en France). Une dépréciation de l'euro accroît donc le prix des importations correspondantes et est donc défavorable à l'industrie allemande. La France a, au contraire, une production industrielle assez basse en gamme, d'où un fort recul des exportations (de la part de marché) lorsque l'euro s'apprécie. La France a, de plus, nettement moins délocalisé la production de composants que l'Allemagne, d'où un moindre bénéfice de l'appréciation de l'euro sur les coûts des consommations intermédiaires de l'industrie. Au total, l'euro fort est favorable à l'Allemagne, défavorable à la France. Comment trouver une politique économique commune ?

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En raison de différences profondes et irréversibles sur quelques années (démographie, niveau de gamme de la production industrielle), l'Allemagne et la France ont des besoins opposés en matière de politique économique : politique monétaire restrictive en Allemagne (pour avoir des taux d'intérêt réels positifs), expansionniste en France (pour obtenir des taux d'intérêt réels négatifs) ; politique budgétaire restrictive en Allemagne (pour réduire la dette publique), expansionniste en France (pour financer des investissements utiles à la croissance) ; absence de soutien de la demande intérieure en Allemagne (pour accumuler des excédents extérieurs), soutien de la demande intérieure en France (besoin de croissance) ; euro fort pour l'Allemagne (industrie haut de gamme avec fortes délocalisations de la production de composants), euro faible en France (industrie bas de gamme avec de moindres délocalisations de la production de biens intermédiaires). Définir une politique économique commune à ces deux pays se révèle très compliqué, sinon impossible. Consultez notre dossier : France-Allemagne : pour le meilleur et pour le pire http://www.lepoint.fr/invites-du-point/patrick-artus/economie-pourquoi-la-france-et-l- allemagne-ne-peuvent-pas-s-entendre-13-06-2014-1835811_1448.php#xtor=EPR-6- [Newsletter-Mi-journee]-20140613

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Daily Morning Newsbriefing June 12, 2014 Let’s not worry too much about house prices We are worried about secular stagnation, youth unemployment, Italian debt sustainability, rising inequality and Marine Le Pen. We are not worried about house prices. Not even in Belgium, a country picked by the IMF among the top five places in the world where price trends are out of line with historic average (more below on what that means). We are not even worried about house price trends in the UK – at least not from a macroeconomic perspective. The reason the 2007 crash was so severe was the build-up of debt. There is no evidence of that happening in Europe, or the UK, where underwriting standards are tighter than ever. When French house prices fell after 2007, it had almost no macroeconomic effects because the French property market was not driven by credit. When the Spanish credit bubble collapsed, the country needed a bailout.

With that preamble in mind – we noted the IMF’s launch of its new Global Housing Watch, which is a useful compilation of data showing global house price trends, and

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how price-rental and price-income ratios deviate from the trends, country-by country. The global data tell us that prices have been rising – back to approximately 2005 levels. Overall levels are not as meaningful information as they seem. With interest rates at zero, and likely to remain low for long periods, it is rational for asset prices to be out of line with past history (as indeed interest rates are out of line with their own past). But as the IMF rightly observes, house prices are constrained by two factors: incomes and rental prices. House price-to-rental and price-to-income ratios have tended to be mean-reverting time series. The following chart shows how current price-rental ratios differ from the historic averages. The graph clearly shows that, in a majority of countries, those ratios are positive which would suggest that prices would decline in the long run – or else rents would have to move up.

Historic averages, however, are potentially misleading. Germany had a long period of falling house prices after unification. Prices have risen lately, partly compensating that fall – but still not going anywhere on any long-term scale. The data show that German price-to-rent ratios are high, but there is no sign of a bubble of the kind policymakers should worry about. In particular, there is no accelerating trend towards more home ownership. If price in the town centre of Munich were to collapse, it would not matter. On the contrary, the macro impact would more likely be positive as rents would become cheaper. Min Zhu, the IMF’s deputy managing director, writes in the IMF blog that the world is still developing the toolkit to fight house price bubbles, suggesting that it should include 317

some combination of macroprudential, microprudential and monetary policy. We would caution against too much optimism about the usefulness of such tools. France's mini-budget asks ministries for 1.6bn extra savings in 2014 The French government published a draft mini-budget on Wednesday that reduces public spending by €3.3bn in 2014 compared to last year, Les Echos reports. It includes another €1.6bn savings from the ministries compared to the initial budget as well as over €1bn of savings in healthcare and welfare spending and a first batch of responsibility pact measures. Some 3.7m households will benefit this year from tax relief measures at a total cost of €1.1bn for the budget, a million more households more than initially announced. This measure is completely counter-financed by the the higher than expected income from anti-tax fraud measures, according to the Journal du Dimanche. Starting next year, workers will also benefit from cuts on the payroll tax they pay - €520 per year for someone on minimum wage, costing the state €2.5bn in total in 2015. For the business sector, the mini-budget includes a one-year extension of the corporate tax surcharge for large enterprises (until 2016), which brings in another €2.5bn. The main part of the responsibility pact is to be unveiled in the second bill on June 18. The debate in parliament promises to be intense as the rebel Socialists' group announced to bring in a series of amendments. France's independent High Public Finance Council, meanwhile, warned on Wednesday the lack of any growth at all in the first quarter makes the government's growth forecast of 1% harder if not impossible to reach, and slower growth could threaten budget deficit targets. Finance minister Michel Sapin says its updated budget plans, combined with the ECB's stimulus measures, should help end the French economy's stagnation. Stournaras to be Greece's central bank governor Yannis Stournaras is to become the next Bank of Greece governor, the central bank said on Wednesday. Stournaras will take over from George Provopoulos when the latter's term ends on June 19, only days after being replaced as finance minister. Greece's main opposition Syriza party said earlier it was against Stournaras's appointment because he was a proponent of the austerity policies it rejects, Reuters reports. Alexis Tsipras described it as a “provocative move by the government, which is disregarding the political balance of power and the need for consultation over such an important position,” Kathimerini reports. Stournaras’s appointment has to be rubber-stamped by the Cabinet and there is also the matter of appointing his deputy. Outgoing Bank of Greece Governor Giorgos Provopoulos warned Wednesday that the country cannot just rely on its adjustment programme moving forward but needs to develop its own growth plan, calling for “the biggest possible consensus of politicians and social forces” over such a scheme. Portugal 10y bonds sells for 3.25% Portugal successfully raised €975m yesterday with its first benchmark 10-year debt issue after the bailout programme ended in May, exceeding its target of €500m-€750m with a demand that was 2.4 times the amount of the debt offer. The interest rates was 3.25%, significantly less that 3.57% of the last issuance in April. It seems that financial markets are largely unimpressed by the constitutional court ruling against the government austerity measures. Portugal's FinMin considers bond issuance to forego last loan tranche 318

The finance ministry is currently considering whether to issue bonds to cover the last outstanding tranche of the bailout programme, according to Jornal de Negocios. If Portugal chooses to forego the final loan tranche from the EU and the IMF, a total of around three billion euros, it will force the debt agency IGCP to issue more debt this year if it wants to maintain the objective of two-third pre- financing for 2015. The Treasury will reach the end of the year with cash reserves of €9.8bn, which corresponds to two-thirds of the funding needs for 2015. The amount of €9.8bn includes the €6.4bn deposited for an eventual need to recapitalize the banking sector. The Bank of Portugal issued a stark warning to policy makers saying that if Portugal wants to fulfill its European commitments it will have to implement fiscal consolidation measures amounting to 4% of the GDP between 2015 and 2019. In its June Economic Bulletin the central bank states that it is "essential" that the "political and social actors" recognizes that this restricts the debate on policy options. Spain’s deposit guarantee fund bounces back from negative net worth Spain’s deposit guarantee fund FGD closed 2013 with a negative net worth of €1.6bn. However, it had revenue of €3.1bn in January and February of 2014 and thus is back in black ink. Commenting on its 2013 annual accounts, the fund claims it is sufficiently capitalised to meet any costs incurred in the sale of Catalunya Bank, which remains under state ownership after the sale of Nova Caixa Galicia last year. The FGD also expects to build up its reserves to €8.5bn or 1% of forecast deposits of Spain’s banking system within 9 years, in line with the latest European directive on deposit insurance which requires the fund to hold an estimated €7bn or 0.8% of system deposits within a decade. AfD to join the Tories The new European Parliament will see a few strange bedfollows – Grillo and Farage, LePen and Wilders, and as Open Europe reports, quite likely the AfD and the Tories. David Cameron does not want it, given his newly discovered strategic tie with Angela Merkel. The blog mentions that the AfD could still get in even if the Tories all vote against them, given the majorities in the group. The Tories only have 19 of the groups 55 MEPs. With 7 AfD MEPs, that number would swell to 62 – which would put the Tory Group ahead of the shrunken ALDE group of Liberals. Open Europe makes the point that Merkel has ruled out any co-operation with the AfD in Germany. So if the AfD were to join Cameron’s party that would make relations more difficult. We also noted that Jean-Claude Juncker’s campaign manager Martin Selmayr has resigned to take up a job at the EBRD. Who could blame him? There was a lot speculation on what that could possibly mean. The answer: we haven’t the foggiest. Deal on ESM bank recapitalisation Reuters reports that governments agreed an ESM recapitalisation facility for banks, linked to strict conditionality. Banks first have to write off at least 8% of their liabilities. It had already been agreed that the maximum volume of direct bank recapitalisation be capped by €60bn. Jeroen Dijsselbloem said that this instrument constituted a last-resort option, to become active when a bank fails to attract sufficient capital from private sources, and if the host member state is not in a position to recapitalise the bank – including through the option of asking for a country bailout earmarked specifically for

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the banking sector. This is an interim regime. From 2016, the single resolution fund will start to take over the role of the backstop. Note: this is not the backstop of the resolution fund, but only an interim agreement to cover the period until the resolution fund takes on the role. It does not affect our own criticism that the fund itself should be backed by the ESM. This is not what has been agreed. A taxonomy of crisis resolution proposals We like the idea of a taxonomy of eurozone crisis resolution proposals, as compiled and discussed by James Galbraith and Yanis Varoufakis on OpenDemocracy.net. We are not going to summarise this rather long article, which obviously features their own proposal prominently. It is interesting that they classify that Glienicker Group as part of the Austerian camp, albeit one of a Federalist complexion. The main dividing line in their taxonomy is austerity and treaty change. We would not draw up categories in this way. For example, it is important to distinguish between pro-cyclical austerity applied during a recession –a policy we have consistently rejected as economically illiterate and politically counter-productive – and fiscal consolidation under positive growth rates. We would favour a policy of strong fiscal consolidation during periods of normal growth (which is not the case today, of course). Tags like “Austerians” or “Federalists” are not helpful because they mean different to different people in Europe. For us, a better taxonomy would classify positions along three dimensions: on legacy debt, economic co-cordination, and political union. On legacy debt, we see four groups: those who advocate transparent joint debt instruments (like us and several others), those who want to muddle through with the maturity extensions and some technical fixes (Angela Merkel), those who want a debt conference, and those who favour exit and default. On economic co-ordination, we see a distinction between those who want to reduce it to the current set of fiscal rules (Germany), those who want a more flexible set of rules (IMF), those who want to include other parts of economic policy in the mix, and those who want to replace rules by some form economic government. On political union, you have the inter- governmentalists who want to anchor political union at the European Council, classic federalists who see the European Parliament in a central role, eurozone-autonomists, who want a parliament for the eurozone, those who favour re-nationalisation – and we probably forgot several other groups. And yes, there are overlaps within groups. The debate on the future of inflation targeting is now in full swing. The latest contribution is from Stephen King, who makes the case for a “looking-at-everything” type approach, of what he euphemistically calls “positive ambiguity”: “Central banks should commit to a steady increase in the price level over the medium to long-term but they should also be willing to tolerate sustained departures of the inflation rate from target, depending on other macroeconomic variables…. “Positive ambiguity” would emphasise that interest rates might rise – or fall – for a whole host of reasons not necessarily connected with the near-term inflationary outlook: credit growth, the balance of payments, asset price inflation and so on. Central banks would inevitably be forced into making judgments, thereby removing the faux- certainty generated by a mechanistic approach to inflation targeting.”

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With so many things to look at, monetary policy becomes unanchored. In a committee like the ECB’s GC, everybody would end up targeting their favourite indicator. We agree that pure inflation targeting is no longer an appropriate framework, and favour a broader-based target, notably a price-level target, or even an NGDP target. The point of a firm target is to steer future expectations, which you can’t do when you are too ambiguous. Also note that the ambiguity about the eurozone’s inflation target (“below, but close to”) has helped inflation rates to come off their anchor. Eurozone Financial Data 10y spreads

Previous This Yesterday day Morning France 0.371 0.400 0.359 Italy 1.376 1.439 1.402 Spain 1.244 1.282 1.254 Portugal 2.061 2.016 1.962 Greece 4.443 4.251 4.34 Ireland 1.085 1.065 1.030 Belgium 0.469 0.498 0.466 Bund Yield 1.332 1.358 1.395

exchange rates This Previous morning Dollar 1.354 1.353

Yen 138.620 137.97

Pound 0.809 0.8058

Swiss Franc 1.218 1.2176

ZC Inflation Swaps previous last close

1 yr 0.71 0.72

2 yr 0.83 0.83

5 yr 1.19 1.19

10 yr 1.6 1.61

Eonia

11-Jun-14 0.06

10-Jun-14 0.07

09-Jun-14 0.05

06-Jun-14 0.07

OIS yield

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curve 1W 0.066 15M 0.050 2W 0.060 18M 0.049 3W 0.065 21M 0.060 1M 0.065 2Y 0.069 2M 0.065 3Y 0.150 3M 0.086 4Y 0.271 4M 0.083 5Y 0.431 5M 0.077 6Y 0.612 6M 0.056 7Y 0.798 7M 0.050 8Y 0.975 8M 0.050 9Y 1.138 9M 0.050 10Y 1.285 10M 0.043 15Y 1.796 11M 0.050 20Y 2.021 1Y 0.041 30Y 2.146

Euribor-OIS Spread previous last close

1 Week 1.943 4.114

1 Month 9.614 9.929

3 Months 17.029 14.971

1 Year 41.457 43.857

Source: Reuters http://www.eurointelligence.com/professional/briefings/2014-06- 12.html?cHash=c936cd27f6ca18fdc36256d72fb0ead8

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Whither Europe? The Modest Camp vs the Federalist Austerians James Galbraith [1] and Yanis Varoufakis [2] 11 June 2014 Proposals are multiplying – especially as evidence mounts that the crisis is continuing, despite all the official announcements of its end. Why not save Europe today, so that we can consider, in due course, how best to proceed with deeper, more difficult measures later on? Soon after the Great Crisis of the Eurozone struck, Europe decided to treat it piecemeal– as though each affected country had committed separate and unrelated policy errors. The governing institutions of Europe denied that the difficulties of Greece, Ireland, Spain, Portugal and Italy could be part of a single disaster, spanning at once the realms of banking, public debt and investment. They placed the full burden of adjustment on the crisis countries – a burden that those countries could not meet, and with a goal, to restore “confidence,” that could never have been achieved by the means chosen. As a result, Europe now faces a chronic depression in its periphery, powerful deflationary forces everywhere else, and a loss of legitimacy in the eyes of its citizens, as the recent European Parliament elections made clear. Yet from the start, there were voices and proposals that insisted on the systemic, continental, European nature of the crisis. These voices are now returning to the stage. Indeed proposals are multiplying – especially as evidence mounts that the crisis is continuing, despite all the official announcements of its end. This article catalogues and describes the new proposals, and argues that they boil down to a choice between two main camps, both of which first emerged quite early on. These are: 1) a ‘Federalist Camp’, who favour a greater concentration of powers in Brussels, and so the constitutional and treaty changes required to bring that concentration into effect, and 2) a ‘Modest Camp’, whose recommendations could be implemented immediately and without major‘constitutional’ or treaty changes. Common ground The common ground between the two camps consists in their agreement that the crisis is a crisis of the Eurozone, and in their agreement that, as such, the crisis is far from over. A group of eleven German economists, known collectively as the Glienicker Gruppe,[i]have prefaced their manifesto [10] (October 2013), with the warning that: “the complacency of large sections of the German public with regard to the euro crisis is not only unfounded: it is dangerous”. Even more poignantly, they suggest that, while the Eurozone’s original rules were right and proper, if their post-2008 enforcement “causes incalculable damage, neither debtors nor creditors will believe the assertion that states must take direct responsibility for themselves. The architecture of the euro area can only be sound and stable if it prevents such collateral damage.” Another, older document, for which we are responsible as co-authors,[ii]known as the Modest Proposal [11] (April 2010, revised July 2013), states that: “Europe is fragmenting. While in the

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past year the European Central Bank has managed to stabilise the bond markets, the economies of the European core and its periphery are drifting apart. As this happens, human costs mount and disintegration becomes an increasing threat.” Much more recently, a group of fourteen French economists, fronted by Thomas Piketty,[iii]issued its own manifesto [12] arguing that the “…European Union is experiencing an existential crisis.... This mainly involves the Eurozone countries, which are mired in a climate of distrust and a debt crisis that is very far from over: unemployment persists and deflation threatens. Nothing could be further from the truth than imagining that the worst is behind us.” A month before that, yet another group of economists, co-chaired by Joseph Stiglitz and Jean- Paul Fitoussi (and including one of us), issued a document [13]which states that: “The EU’s political fragility has been made worse by the damage the on-going crisis has inflicted and continues to inflict on its citizens, on its economies and welfare systems, and increasingly, on the quality of its democracies.”[iv] Thus a variety of groups of economists of different persuasions and nationalities, have reached the same conclusion: that current policies threaten the European project, jeopardize any chance for shared European prosperity, and are poisoning European democracy into the bargain. Yet the solutions proposed by these groups differ quite fundamentally. Before one can understand what is on offer, and how the proposals differ, it is useful to look at their origins. A brief history of the various proposals The first two proposals appeared in 2010. The Bruegel Blue Bond [14] (BB) proposal[v](which was later augmented in 2011 by Bruegel’s Comprehensive Solution to the Euro Crisis [15][vi]) and our Modest Proposal [11] (MP) addressed the three sub-crises that made up the broader crisis of the euro: public debt, insolvent banks and low investment. • On the public debts, both BB and MP suggested that the debt of member-states be split into two parts: a ‘good’ and a ‘bad’ part (‘blue’ and‘red’ parts according to BB, or ‘Maastricht Compliant’ and ‘Maastricht Violating’ parts according to MP).[vii] The two proposals also recommended that the ‘good’, ‘blue’ or ‘Maastricht Compliant’ be‘Europeanised’.[viii] • On the banks, BB and MP recommended disentangling the insolvent banks from the fragile member-states by assigning to the newly formed European Financial Stability Mechanism (which later morphed into the European Stability Mechanism) the role that TARP (the Troubled Assets Relief Program) had played in the United States; that is to recapitalize the failed banks directly. • On investment, the two proposals argued that sorting out public debt and banking losses would not suffice for the purposes of restoring growth. While BB and MP were similar in some respects, their differences were also significant. And the differences led to divergent proposals later on, when other economists took up and built on (especially) the original BB suggestions. So, to understand the recent crop of blueprints, and the reasons why they differ as much as they do, it helps to analyze the differences between the two proposals that came out in 2010: BB and MP. Different public debt reduction strategies: BB recommended that the “good” part of a member-state’s debt be ‘Europeanised’, or pooled, using common bonds – or eurobonds – that are jointly backed by all member-states. Participation of a particular member-state in eurobonds would be conditional on a pledge to drive that member-state’s‘bad’ public debt (i.e. that part which exceeded the Maastricht criteria of 60 percent of GDP) to zero within a specified period and would have to be vetted by a newly established Independent Stability Council (ISC) and by

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each and every Eurozone member-state parliament. BB was adamant on its strict, and cumbersome, conditionality: “In order to be admitted to the Blue Bond scheme, countries would have to convince the ISC that their fiscal policy is credible enough to be insured (via the joint and several liability) by the most credible countries of the euro area. For example, one could imagine that a country would not be allowed into the Blue Bond pool if it did not have a binding fiscal rule, analogous to the one inserted by Germany into its constitution.” [BB, 2010] But why would pooling debts from crisis countries lead to a lower interest rate on those debts? Surely, the joint interest rate must be higher than, say, Germany would pay for its own public debt. It is hard to see why German taxpayers would provide this ballast which, in any event, might end up with interest rates that are not only too high for Germany but also insufficiently low for the crisis countries. Furthermore, it would do nothing to relieve the severe austerity that BB de facto demands of the crisis countries: the conditionality clause committing them to eliminate their “bad” debt within a pre-agreed period (and independently of their growth performance). Whether German taxpayers would be placated by the formation of an ISC, and by the veto power of national parliaments, is uncertain. But what is certain is that these provisions would introduce a degree of insufferable inflexibility into a scheme of uncertain effectiveness. For this reason the MP suggested a simple alternative to issuing jointly issued and severally guaranteed bonds, or eurobonds, with eighteen parliamentary approvals, plus the green light from an ISC, as pre-conditions: Upon a simple request from a member-state, the ECB should service a portion of each maturing government bond equal to the member-state’s ‘good’, ‘blue’ or ‘Maastricht Compliant’ debt. And how would the ECB pay for this ‘servicing’? By issuing its own bonds (ECB-bonds) and then passing on the cost of servicing these bonds to the member-state on whose behalf the ECB issued them.[ix]This would assuredly reduce interest rates on that portion of the debt, since the ECB bonds would secure ultra-low interest rates without imposing any requirement on say, German taxpayers. It would also reduce the risk of the non-compliant(or ‘red’ in BB’s parlance) tranche, in each country, thus lowering the overall interest burden on the crisis countries. Overall, the present value of Eurozone-wide public debt would fall by at least one third overnight, without having the surplus countries back, or buy, the debts of the deficit ones. As for conditionalities, there would be none, except that the participating member-state would agree to grant super-seniority status to its debt to the ECB. No joint liability between the government of Germany and of Portugal, no parliamentary approvals, no new ISC, no destructive austerity measures in order to eliminate the ‘red’, Maastricht-violating parts of public debts. Different strategies for growth:BB and MP differed also on the method for boosting public investment and the conditions to be imposed on member-states. BB promoted IMF-style structural adjustment programs (SAPs) for the European periphery, in precisely the same way that the latter had been imposed on developing nations prior to 2008. It recommended that the EU’s unspent structural adjustment funds, amounting to no more than 0.8% of Euro Area GDP, be disbursed for public investments in the crisis countries, only after the latter had implemented the usual array of IMF-like structural reforms, with the emphasis on ‘labor market flexibility’,privatization and so forth. A year later, the IMF-SAP logic in BB was articulated fully in the Chatham House (CH) Real Marshal Plan [16]proposal (June 2012).[x] MP countered BB’s proposal on two grounds: First, an investment drive of 0.8%, even 1%, of Euro Area GDP was far too feeble. MP counter-proposed a New Deal-like injection of up to 8% of Euro Area GDP, or ten times the BB proposal. Second, MP ruled out extracting the funds necessary from the EU budget or through heavier taxation. MP proposed, instead, an Investment-led Recovery Program administered by the European Investment Bank (EIB) and its

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sister organization the European Investment Fund (EIF), without any formal guarantees or fiscal transfers by member states. The EIB-EIF would raise the entire amount from the money markets - as the EIB has been doing for decades - with the ECB standing behind the EIB-EIF either directly (through supportive net ECB-bond issues that pooled the risk between the ECB and the EIB-EIF[xi]) or, as might be preferred today by the ECB’s Governing Board, through quantitative easing that takes the form of ECB purchases of EIB-EIF bonds in the secondary markets. Either way, the yields on these bonds would be kept low while the EIB-EIF are administering a large-scale investment program capable of getting Europe back on its feet. In summary, the two main proposals that emerged in 2010 were united in their determination to address the crises of public debt, of banks and of substandard investment, However, they differed in two important ways: On public debt: BB’s proposal would pool the periphery’s ‘good’ part of public debt by having Germany (and other surplus countries) take on a measure of this debt on behalf of the deficit nations and in exchange for stringent austerity in the periphery that would serve the purpose of eliminating their ‘bad’ debts. • MP would restructure the public debt without any fiscal transfers, without any guarantees of the crisis countries’ debts by the surplus nations, and without further destructive austerity. On public investment: BB envisioned the imposition of IMF-like SAPs, in exchange for tiny doses from the EU’s unspent structural funds pool. • MP recommended a European New Deal run by the European Investment Bank (and the European Investment Fund) and funded by the EIB-EIF itself, with the ECB’s backing. This would require no increase in taxation either at the EU or at the member-state level and, therefore, no fiscal transfers. Federalist Austerians: Three recent proposals stemming from the original Bruegel Plan (BB) In November 2011 Germany’s Council of Economic Advisors borrowed heavily from Breugel’s ‘Blue Bond’ proposal (BB) to present its idea for a European Debt Redemption Fund [17] (ER). As in BB, the ER proposal was all about eliminating the ‘bad’ debts through a deal between surplus and deficit member-states according to which: (a) surplus nations would agree to mutualize part of the debt of the crisis states, and (b) the crisis states would agree to run down these ‘bad’ debts (down to the Maastricht-compliant level) within a period of twenty years (give or take) through substantial primary budget surpluses. There were three innovations of ER over BB. First, instead of mutualizing (through jointly and severally issued eurobonds) the periphery’s‘good’ or ‘blue’ debts, ER recommended that ‘bad’ or ‘red’ debts should be mutualized in the same manner. Secondly, the participating crisis states would introduce German-style debt brakes in their constitutions. Thirdly, they would offer collateral to the European Redemption Fund (in the form of gold and foreign exchange reserves, as well as public assets) that would be forfeited if agreed debt reduction strategies were abandoned or pursued too meekly. Both BB and ER required the issue of common bonds, or jointly and severally issued eurobonds. But these were ruled out both by the German government and by the German constitutional court, for violating the no fiscal transfer (or no bailout) clause of existing Treaties, even if they were meant to be temporary.[xii] In October 2013, the Glienicker Gruppe of German economists issued their manifesto [10] (GG) taking the ER and BB proposals to the final step. Accepting the Court decision, GG suggested a treaty revision to legalize temporary eurobonds. And since the Treaty was to be changed, GG

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added to the revised Treaty provisions for a Euro-government that would be funded by 0.5% of the member-states’ tax revenues, that would administer a common unemployment insurance fund, and that would ensure austerity in the periphery never reaches the point of degrading essential public goods and services. Moreover, GG recommended that a new chamber of the Euro-Parliament be convened, to approve and to supervise the aforementioned Euro-government, comprising the Members of European Parliament (MEPs) from the Eurozone. More recently still, another manifesto [12] was published, this time in France by a group of fourteen economists headed by Thomas Piketty (see note 3). The Piketty Group [12] (PG) accepts GG’s basic principles and takes them further in the following two ways: First, PG amend GG’s Euro-Parliament idea slightly, arguing that it should be made up not of MEPs but of national parliament representatives in proportion of the population of each Eurozone member-state.[xiii]Second, PG argue that the Euro-government should be funded not from the member-states’ general tax revenues but, exclusively, by pooling together a proportion of corporate taxes.[xiv] Otherwise, PG is a variant of GG and represents an attempt to re-build the Franco-German axis, at least in the realm of manifestoes on how to fix the Eurozone. The Modest Camp: The Modest Proposal 4.0 (MP) and The Call for Change (CC) In July 2013 our Modest Proposal [18] was revamped, and published (as Version 4.0) with the endorsement of M. Rocard, formerly France’s Prime Minster. The main amendments were three. First, instead of the so-called Banking Union to which Europe’s leaders recently agreed, MP recommends a step-by-step approach to banks, beginning with the banks that need public funds to be recapitalized. These, and only these banks, we argued, should be recapitalized directly by the European Stability Mechanism (in exchange for equity that stays with the ESM), with new Boards of Directors appointed by the ECB supervisors. Once cleansed of bad assets, banks can be sold back to the private sector, thus repaying the ESM with interest. Secondly, having already recommended that the EIB-EIF ought to issue enough bonds, without any guarantees from member-states, to fund an investment-led recovery program to the tune of 8% of Euro Area GDP, we proposed that the ECB ought to step into the secondary bond market and purchase as many of the EIB-EIF bonds as are necessary to keep the EIB-EIF bond yields at their present, ultra-low levels. This means that the ECB would enact quantitative easing (as it ought to at a time of zero interest rates and deflationary headwinds) by buying AAA-rated bonds that: do not violate any Treaty; do not count against national debt limits; and which are not backed by member-states. This is precisely what the EIB-EIF bonds are![xv] Thirdly, MP4.0 included a policy for combating a fourth crisis, the result of four years of policy paralysis and self-defeating austerity. This is a policy to address the human and social crisis of the Eurozone. Specifically we propose a program of social solidarity, focused on food and energy security for the most vulnerable Europeans in the countries too impoverished by the crisis to provide it. Unlike the Federalist Austerian proposals (PG-GG-ER), MP does not recommend the creation of a Euro-government to administer this, nor does it propose pooling of taxes. Instead, it advocates a food and energy stamp program to be funded by the accumulating interest on the European System of Central Banks’ internal accounting system known as TARGET2. These may be supplemented by other Eurozone-wide financial transaction taxes, as they come on stream in the future).[xvi] In May 2014, the Scientific Board of the Progressive Economy Foundation of European Socialists and Social Democrats, co-chaired by Joseph Stiglitz and Jean-Paul Fitoussi (and co- signed by one of us[xvii]) issued its own manifesto, entitled A Call for Change [19] (CC) drawing heavily upon the MP proposals on banks, public debt, investment-led recovery and

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social solidarity, and extending its analysis and focus to matters touching upon social justice and inequality. As Prime Minister Rocard says in his preface to the Modest Proposal’s Version 4.0, while there is nothing modest about its ambition, it is nonetheless modest in that it requires no Treaty changes nor the federal moves advocated by the Federalist Austerians.

[20]

Note that the first plans, BB, MP and CH, were all of the modest variety, in that they were intended to be implemented without Treaty changes and, certainly, without federalism. CH was not comprehensive enough – it had no plan for public debt or the banking crisis– and was incorporated alongside BB into the ER – which had to move in a Treaty Change-Federal direction as the jointly and severally issued eurobonds necessitated Treaty changes and even a Euro-government. This is something that GG and then PG acknowledged. That left only MP, and then CC, as the “modest plans.” Two key issues: austerity and treaty changes First key issue: austerity, or not? The Glienicker Gruppe manifesto [10] (GG) says almost nothing specific about austerity, beyond the general comment that it must not be pushed too far: “It is therefore inevitable that taxpayers will have to shoulder a large share of the burdens of the crisis, and suffer painful reforms. But the limit of responsibility when livelihoods are threatened. If in Greece, Portugal or Spain, a whole generation is deprived of their chance to live a productive life, it is not just a Greek, Portuguese or Spanish problem, but one that affects us all as citizens of the EU.” This is a worthy sentiment but it does not tell us what is to be done. Later in the document, it becomes clear that, for GG, the very purpose of a European government is more effective implementation of binding austerity measures. This is inescapable as GG is based on the 2011 ER, which was based on the original 2010 BB, the purpose of which was to ‘trade’eurobonds (to which Germany would concede) for a large-scale austerity drive in the periphery. GG states: “As long as member states comply with their obligations, this may involve only non-binding recommendations. If a member state, however, violates the stability criteria, the economic governmentmust be able to make binding stipulations of how much the state as to save– the state will keep the decision where to save.” (Italics added)

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It is not clear how the ‘binding stipulations’ would differ in practice from the current regime of the troika, except that they would be imposed by a new Euro-government with more legitimacy than the troika can muster. Apart from this, GG merely calls for limited central support of essential public goods, funded by a‘membership fee’. The Piketty Group [12] (PG) welcomes the Glienicker language, describing it as proposals to “strengthen the political and fiscal union of the eurozone countries.” The declared purpose of PG is to “take the proposals of the Glienicker Gruppe still further.” Nowhere does PG take exception to the concept of binding stipulations for a state that violates the stability criteria. This is so because it shares GG's commitment to the 2011 European Redemption Fund, which is fundamentally austerian in logic. Thus it joins in calling for Treaty changes that will create the strong Euro-government to implement the austerity programs that, to date, have not been sufficiently severe. In contrast, the Modest Proposal [18] proposes: … a European New Deal which, like its American forebear would lead to progress within months, yet through measures that fall entirely within the constitutional framework to which European governments have already agreed. Instead of securitizing the toxic parts of Eurozone member debts (as ER,GG and PG recoomend), the MP [18] would have the European Central Bank issue bonds to cover the Maastricht-compliant first60 percent – the safest portion – of each participating country's national debt. Simultaneously, the ECB would back an Invesment-led Recovery Program, funded and administered by the European Investment Bank and the European Investment Fund. The MP’s plan would therefore ease the debt crisis. It would do so without requiring further destructive austerity measures, without further non-credible long-term debt-reduction charades, without joint debt issues by deficit and surplus member states, and without appeals to the risk- takers in the private financial markets. The Progressive Economy Foundation's Call for Change [19] is anti-austerity too. It recommends: ...a comprehensive policy involving income stabilisation, a more considered and growth- oriented approach to fiscal consolidation, increased social and infrastructure investment, debt restructuring, and social support would have produced both stronger economic performance and a better debt and financial outlook. Both the MP and the CC place their emphasis mainly on growth, investment, debt-restructuring and the deployment of existing institutions so as to ‘Europeanize’ part of the public debt, the failed banks, the funding of large scale investment projects, and the relief of food and energy deprivation amongst Europe’s citizens who have been struck by the crisis. And to do this with no fiscal transfers, no German or Dutch guarantees of Greek or Portuguese debt, no tax financing whatsoever. On austerity, a further difference concerns the fiscal requirements for an investment or social- solidarity program. Amongst the Federalist Austerians, the PG would turn to pooled corporate taxes, while the GG would impose a levy on national tax revenues. But neither would spend more than revenue raised. Even if the intended investment were large, its multiplier effect would be small.[xviii] This is not a counter-austerity or an anti-crisis program, but one that keeps repeating the tired call for more ‘labour market flexibility’.[xix]In contrast, the Modest Proposal’s Investment-led Recovery Program is both large (8% of Euro Area GDP) and funded by harnessing the idle savings now sloshing around in the global financial markets. Second key issue: Treaty changes? The second key issue separating the two camps (Modest and Federalist Austerian) concerns the need for a new European Treaty. To support their modified austerity regimes, the Glienicker and Piketty Groups both call for radical restructuring of the European Union and the Eurozone. In 329

particular, they call for the creation of a new Euro-government, complete with a Euro- Parliament or Euro-Chamber. Neither flinches from the task of writing the new European Treaty that this would require. The Modest Proposal takes a different view. MP argues that if the crisis remains severe (as all groups agree) then impossible objectives should not be set; especially if they are also unnecessary and undesirable.[xx] Instead, the key tasks are first to stabilize Europe, to bring about an atmosphere of genuine European solidarity, to stop the economic and political fragmentation of the Continent (so far as possible within the existing European Treaties) and, only then, to debate the possibility of a Federal Europe. In the article outlining his group’s manifesto [12], Thomas Piketty dismisses concerns that Treaty changes are unlikely to be passed by our eighteen electorates (in the middle of the current crisis) as “false and dangerous”. He adds: “The treaties are being modified constantly, as was the case in 2012, when the matter was settled in a little more than six months. Unfortunately, this was a poor reform.” Indeed it was. The only reason it passed was that it was fiercely promoted by Germany, so as to strengthen the iron cage in which the periphery, and France, are now confined. A new Euro- government, as GG and PG propose, would pass only if it were meant to solidify this iron cage further. At this date, we believe that changes in policy must come immediately, and must be sought within the existing Treaties. Only then will they (a) succeed and (b) allow Europe a chance to design future institutions whose logic will not be that of perpetual austerity, inequality and domination. The Modest Proposal [18] is designed for this purpose. Each of its elements – ECB bonds, case- by-case bank resolution, an investment program and a solidarity fund– can be implemented by existing authorities within the time permitted by the gravity and urgency of the crisis. And that time, we believe, is short. The Modest Proposal [18] and The Call for Change [13]thus ask: Why not us? Why not now? Why not act with the powers at hand? Why not take the feasible steps? Why not solve the problems we can solve with the tools that we have? Why not save Europe today, so that we can consider, in due course, how best to proceed with deeper, more difficult measures later on? That is the question.

[i] The Glienicker Gruppe comprises Armin von Bogdandy, Christian Calliess, Henrik Enderlein, Marcel Fratzscher, Clemens Fuest, Franz C. Mayer, Daniela Schwarzer, Maximilian Steinbeis, Constanze Stelzenmüller, Jakob von Weizsäcker, Guntram Wolff. [ii] The Modest Proposal for Resolving the Euro Crisis [11] was co-authored by Yanis Varoufakis, Stuart Holland and James K. Galbraith. [iii] The Piketty Group (PG) includes, besides Thomas Piketty: Florence Autret, Antoine Bozio, Julia Cagé, Daniel Cohen, Anne-Laure Delatte, Brigitte Dormont, Guillaume Duval, Philippe Frémeaux, Bruno Palier, Thierry Pech, Jean Quatremer, Pierre Rosanvallon, Xavier Timbeau, Laurence Tubiana. [iv] The European Progressive Policy initiative was launched in 2013 by the Group of the Progressive Alliance of Socialists and Democrats in the European Parliament. It is made up of: Joseph E. Stiglitz, Jean-Paul Fitoussi, Peter Bofinger, Gosta Esping-Andersen, James K. Galbraith, Ilene Grabel, Stephany Griffith-Jones, András Inotai, Louka T. Katseli, Kate Pickett, Jill Rubery, Frank Vandenbroucke. The policy document they issued is entitled A CALL FOR CHANGE: From the Crisis to a New Egalitarian Ideal for Europe [13].

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[v] See Bruegel’sBlue Bond Proposal [14], May 2010, authored by Jacques Delpha and Jakob von Weizsacher. [vi] Authored by Zsolt Darvas, Jean Pisani-Ferry, André Sapir February 2011 [vii] Where the ‘good’, ‘blue’ or ‘Maastricht Compliant’ debt equalled debt up to 60% of a member-state’s GDP; the rest being labelled ‘bad’, ‘red’ or‘Maastricht Violating’ debt. [viii] Quoting from BB (2010), its authors’ main proposal was to institute: “Blue Bonds: EU countries should pool up to 60 percent of GDP of their na-tional debt under joint and several liability as senior sovereign debt, there-by reducing the borrowing cost for that part of the debt. Red debt: Any national debt beyond a country’s Blue Bond allocation should be issued as national and junior debt with sound procedures for an orderly default, thus increasing the marginal cost of public borrowing and helping to enhance fiscal discipline. Independent Stability Council (ISC): Blue Bond allocations to member states are to be proposed by an ISC and voted on by member states parliaments in order to safe-guard fiscal responsibility.” In contrast, MP (2010) stipulated: “The creation of ECB bonds for the levels of debt already allowed for by the Maastricht Treaty (60% of a country's GDP) will pool Europe's borrowing resources together and ensure that, as long as a country stays within the Maastricht debt limits, it will be paying the same interest on its debt. Compared to the EFSF, which generates terrible risks similar to those of the toxic derivatives on the basis of interest rate differentials (see Appendix A), this simple tranche transfer will lower systemic risks significantly. Moreover, a ‘tranche transfer’ would not be a debt write-off. The member states whose bonds are transferred to the ECB would be responsible for paying the interest on them, but at much lower rates. Additionally, by issuing ECB bonds, it would attract investments from the Central Banks of surplus economies (i.e. China, Japan, ) and also sovereign wealth funds (e.g. Chinese, Norwegian, UAE) which are seeking to diversify the way their surpluses are invested. Indeed, that could herald the rise of the euro as a true reserve currency.” [ix] The idea here is that the ECB, upon issuing its bonds to service, say the Maastricht Compliant portion of a maturing Italian bond, will simultaneously open a debit account for Italy in which the Italian state will be committed to paying the monies necessary for servicing the coupons and the final redemption of these ECB bonds. [x] The author of which was Nicholas Crafts. The full title of CH was: Saving the Eurozone: Is a ‘Real’ Marshall Plan the Answer? [16], June 2012. [xi] The MP stated: “Member-states, regardless of whether they have chosen or not to participate in the tranche transfer of their Maastricht-compliant debt (N.b. recall the MP’s proposal for the issue of ECB- bonds for the purposes of alleviating member-states’ ‘good’ or ‘blue’ debt)are now invited to co-finance, along with the EIB, 50% of the cost of new investment projects, that are approved by the EIB, through a bond account held by the ECB. The ECB issues the bonds necessary for the purpose on behalf of the member-state, this new debt does not count as part of the national debt but, however, it is serviced by the member-state from the revenues of the projects and by means of long-term amortisation of their existing debit account at the ECB.” [xii] Member-states, regardless of whether they have chosen or not to participate in the tranche transfer of their Maastricht-compliant debt (see Policy 1) are now invited to finance investment projects that are approved by the EIB through an e-bond account held by the ECB. The ECB issues the e-bonds necessary for the purpose on behalf of the member-state, this new debt does

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not count as part of the national debt but, however, it is serviced by the member-state by means of long term amortisation of their existing debit account at the ECB. [xiii] The argument here being that national Parliaments maintain the right to tax and spend, and this right cannot be passed on to MEPs. [xiv] PG argue that this will also help prevent some countries (like Ireland) from playing the tax-optimisation, beggar-thy-neighbour game. [xv] See this article [21] for more on this recommendation. [xvi] The reason for recommending that TARGET2 ‘profits’ are used in this manner, to fund food stamps and minimal energy provisions for the weakest Euro Area citizens, is that they are directly proportional to the magnitude of the crisis that is, after all, responsible for the observed deprivation that causes the need for food stamps etc. [xvii] James K. Galbraith [xviii] It is true that tax-financed spending is expansionary. Contrary to what many think, when new public spending is exactly matched by new revenue, the economy grows. But the target sums – one-half to one percent of GDP--- are feeble. And the multiplier is small, so an investment program limited to tax receipts or fees will have at best a weak effect on the whole Eurozone. And it is likely that most of that money would be spent in the core economies, where conditions are least grave. [xix] The Piketty Group makes no mention of European social policy. In this respect, the Glienicker Group makes an important, though qualified statement of necessary action: The monetary union cannot be permanently stable without a controlled transfer mechanism. … we need a euro-area insurance mechanism to cushion the fiscal consequences of a dramatic economic downturn. The euro area could therefore establish a common unemployment insurance system, to complement national systems; all countries that organise their labour market in line with the needs of the monetary union could be eligible for participation. This would create a mechanism to counteract deep recessions with automatic European stabilisers. We hail this statement. Common automatic stabilization played the central role in saving the United States from disaster. A common automatic stabilization for Europe is precisely what has been lacking, precisely what is needed. But there is no need to qualify this need with a call for common organization of labor markets. Stabilization and social-solidarity programs are per seessential. And the crisis should have disabused all of the notion that‘flexible labor markets’ add to the stability or resilience of any economy. [xx] Undesirable because the proposed Euro-government is envisaged as the enforcer of more self-defeating austerity. And unnecessary because, as the Modest Proposal demonstrates, debt, banks, investment and social solidarity can be ‘Europeanised’ without a new Euro-government or a Euro-Parliament; i.e. without the political tumult of creating them. About the authors Yanis Varoufakis is Professor of Economics at the University of Athens and Visiting Professor at the Lyndon B. Johnson Graduate School of Public Affairs, University of Texas, Austin. He is the author of The Global Minotaur [22] (Zed Books). His blog is here [23]. James K. Galbraith is director of the University of Texas Inequality Project.He writes a regular column on economic and political issues for the Texas Observer.

Source URL: http://opendemocracy.net/can-europe-make-it/james-galbraith-yanisvaroufakis/whither-europe-modest-camp-vs-federalist-austeri

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Links: [1] http://opendemocracy.net/author/james-galbraith [2] http://opendemocracy.net/author/yanis-varoufakis [3] http://opendemocracy.net/topics/international-politics [4] http://opendemocracy.net/topics/ideas [5] http://opendemocracy.net/topics/economics [6] http://opendemocracy.net/topics/democracy-and-government [7] http://opendemocracy.net/countries/eu [8] http://www.facebook.com/sharer.php?u=http://opendemocracy.net/print/83632&t= Whither Europe? The Modest Camp vs the Federalist Austerians [9] http://twitter.com/share?text= Whither Europe? The Modest Camp vs the Federalist Austerians [10] http://www.glienickergruppe.eu/english.html [11] http://yanisvaroufakis.eu/euro-crisis/modest-proposal/ [12] http://www.theguardian.com/commentisfree/2014/may/02/manifesto-europe-radical- financial-democratic [13] http://varoufakis.files.wordpress.com/2014/05/european-progressive-policy-initiative- endorsing-mp4-0.pdf [14] http://www.bruegel.org/publications/publication-detail/publication/403-the-blue-bond- proposal/ [15] http://www.voxeu.org/article/three-part-plan-tackle-eurozone-debt-crisis [16] http://www.chathamhouse.org/sites/default/files/public/Research/International%20Economics/0 612bp_crafts.pdf [17] http://www.sachverstaendigenrat-wirtschaft.de/schuldentilgungspakt.html?&L=1 [18] http://varoufakis.files.wordpress.com/2013/07/a-modest-proposal-for-resolving-the- eurozone-crisis-version-4-0-final1.pdf [19] http://www.progressiveeconomy.eu/sites/default/files/PROGRESSIVE_ECONOMY_ACallfor ChangesEN.pdf [20] http://www.opendemocracy.net/files/imagecache/wysiwyg_imageupload_lightbox_preset/wysi wyg_imageupload/537772/Figure1.png [21] http://yanisvaroufakis.eu/2014/05/19/how-should-the-ecb-enact-quantitative-easing-a- proposal/ [22] http://yanisvaroufakis.eu/books/the-global-minotaur/ [23] http://yanisvaroufakis.eu/ [24] http://creativecommons.org/licenses/by-nc/3.0/ [25] http://www.opendemocracy.net/contact

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Economics

Nouriel Roubini, professor at NYU’s Stern School of Business and Chairman of Roubini Global Economics, was Senior Economist for International Affairs in the White House's Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank. MAY 31, 2014 The Great Backlash NEW YORK – In the immediate aftermath of the 2008 global financial crisis, policymakers’ success in preventing the Great Recession from turning into Great Depression II held in check demands for protectionist and inward-looking measures. But now the backlash against globalization – and the freer movement of goods, services, capital, labor, and technology that came with it – has arrived. This new nationalism takes different economic forms: trade barriers, asset protection, reaction against foreign direct investment, policies favoring domestic workers and firms, anti-immigration measures, state capitalism, and resource nationalism. In the political realm, populist, anti-globalization, anti-immigration, and in some cases outright racist and anti-Semitic parties are on the rise. These forces loathe the alphabet soup of supra-national governance institutions – the EU, the UN, the WTO, and the IMF, among others – that globalization requires. Even the Internet, the epitome of globalization for the past two decades, is at risk of being balkanized as more authoritarian countries – including China, Iran, Turkey, and Russia – seek to restrict access to social media and crack down on free expression. The main causes of these trends are clear. Anemic economic recovery has provided an opening for populist parties, promoting protectionist policies, to blame foreign trade and foreign workers for the prolonged malaise. Add to this the rise in income and wealth inequality in most countries, and it is no wonder that the perception of a winner-take-all economy that benefits only elites and distorts the political system has become widespread. Nowadays, both advanced economies (like the United States, where unlimited financing of elected officials by financially powerful business interests is simply legalized corruption) and emerging markets (where oligarchs often dominate the economy and the political system) seem to be run for the few. For the many, by contrast, there has been only secular stagnation, with depressed employment and stagnating wages. The resulting economic insecurity for the working and middle classes is most acute in Europe and the eurozone, where in many countries populist parties – mainly on the far right – outperformed mainstream forces in last weekend’s European Parliament election. As in the 1930’s, when the Great Depression gave rise to authoritarian governments in Italy, Germany, and Spain, a similar trend now may be underway. 334

If income and job growth do not pick up soon, populist parties may come closer to power at the national level in Europe, with anti-EU sentiments stalling the process of European economic and political integration. Worse, the eurozone may again be at risk: some countries (the United Kingdom) may exit the EU; others (the UK, Spain, and Belgium) eventually may break up. Even in the US, the economic insecurity of a vast white underclass that feels threatened by immigration and global trade can be seen in the rising influence of the extreme right and Tea Party factions of the Republican Party. These groups are characterized by economic nativism, anti-immigration and protectionist leanings, religious fanaticism, and geopolitical isolationism. A variant of this dynamic can be seen in Russia and many parts of Eastern Europe and Central Asia, where the fall of the Berlin Wall did not usher in democracy, economic liberalization, and rapid output growth. Instead, nationalist and authoritarian regimes have been in power for most of the past quarter-century, pursuing state-capitalist growth models that ensure only mediocre economic performance. In this context, Russian President Vladimir Putin’s destabilization of Ukraine cannot be separated from his dream of leading a “Eurasian Union” – a thinly disguised effort to recreate the former Soviet Union. In Asia, too, nationalism is resurgent. New leaders in China, Japan, South Korea, and now India are political nationalists in regions where territorial disputes remain serious and long-held historical grievances fester. These leaders – as well as those in Thailand, Malaysia, and Indonesia, who are moving in a similar nationalist direction – must address major structural-reform challenges if they are to revive falling economic growth and, in the case of emerging markets, avoid a middle-income trap. Economic failure could fuel further nationalist, xenophobic tendencies – and even trigger military conflict. Meanwhile, the Middle East remains a region mired in backwardness. The Arab Spring – triggered by slow growth, high youth unemployment, and widespread economic desperation – has given way to a long winter in Egypt and Libya, where the alternatives are a return to authoritarian strongmen and political chaos. In Syria and Yemen, there is civil war; Lebanon and Iraq could face a similar fate; Iran is both unstable and dangerous to others; and Afghanistan and Pakistan look increasingly like failed states. In all of these cases, economic failure and a lack of opportunities and hope for the poor and young are fueling political and religious extremism, resentment of the West and, in some cases, outright terrorism. In the 1930’s, the failure to prevent the Great Depression empowered authoritarian regimes in Europe and Asia, eventually leading to World War II. This time, the damage caused by the Great Recession is subjecting most advanced economies to secular stagnation and creating major structural growth challenges for emerging markets. This is ideal terrain for economic and political nationalism to take root and flourish. Today’s backlash against trade and globalization should be viewed in the context of what, as we know from experience, could come next. http://www.project-syndicate.org/commentary/nouriel-roubini-likens-the-rise-of-nationalism-today-to- that-of-authoritarian-regimes-during-the-great-depression

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Maastricht and the Crisis in Europe: Where We’ve Been and What We’ve Learned By Reza Moghadam Director, European Department ECB/NBB Conference: “Progress through crisis?” Brussels, Wednesday, February 12, 2014 As Prepared for Delivery Everywhere, but especially in Europe, the crisis has exposed gaps in our belief systems and institutions. This symposium on Maastricht and the road ahead is an opportunity to take stock of the presuppositions about what it takes to deliver financial stability and an enduring EMU. In this talk, I will advance the following line of argument: • The Maastricht mindset saw fiscal indiscipline as the primary risk to the viability of the euro. Hence, its pre-occupation with fiscal rules and no bailout clauses. • But the pernicious forces at work before the crisis were not just about fiscal indiscipline, but more so, financial market indiscipline which priced risk more or less uniformly across the euro area and allowed, via banks, the build-up of large cross-border debts. • When the crisis hit, the unsustainability of these private sector imbalances became apparent, threatening to bring down the banking system. It was assumed that private imbalances would remain a private sector problem, but instead some of this became public sector debt. • The reality of the crisis has realigned the mindset. An explicit regime for bailout using ESM was invented. Fiscal rules were adapted and recast in structural terms. The need to monitor current account imbalances and other balance sheet weaknesses was recognized. • Most importantly, rules are being developed to instill financial market discipline and ensure adequate burden sharing between the public and private sectors. Unified supervision, a resolution mechanism, clear bail-in rules, and a common backstop for bank resolution are critical elements. • Progress has certainly been made, but Europe still has much work to do on some of these post-Maastricht adaptations if it is to lay the basis for stability and growth.

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Maastricht’s fiscal focus Maastricht’s promise was that by giving up monetary autonomy, members of EMU would see their incomes rise with increases in trade and the free flow of labor and capital. By eliminating exchange rate uncertainty and lowering borrowing and transactions costs, members would receive large benefits for a small loss of sovereignty. But it was understood that the centralization of monetary policy could carry some risks: country specific shocks could go unaddressed, while fiscal profligacy by members could lead to pressures for monetary financing. To address these risks, some kind of fiscal coordination and integration would have needed to accompany the monetary union, as recognized in the MacDougall and Delors reports. The consequences of country-specific shocks could have been reduced by fiscal risk-sharing across members. But to ensure that it would not be abused, members would have had to cede some of their fiscal autonomy to the center. However, when Maastricht was being drawn up, such a loss of sovereignty was not politically feasible. A compromise was needed, one that would mitigate the risks, while at the same time preserving a large degree of members’ fiscal autonomy. As a result, the Maastricht framework and its implementing agreements, like the Stability and Growth Pact, tried to resolve these tensions by putting in place strict fiscal rules for members: • Countries would maintain their fiscal independence, but would respect limits on the size of public debt and deficits. • The “no bailout” clause meant that no country participating in EMU could expect another country to bail it out. The fiscal targets were thought to be generous enough that they would enable countries to respond effectively to shocks, while being restrictive enough to ensure that countries debt and deficits could not spiral out-of-control or diverge too much. The “no bailout” clause was supposed to encourage markets to discipline sovereigns, by pricing their debt according to their credit risks. Taken together with the assumption that the framework would be self-enforcing, Maastricht seemingly addressed the tradeoff between sovereignty and solidarity. Maastricht meets reality From the start though, practice was different from theory. Countries (e.g., Greece and Italy) were allowed to enter EMU, despite failing to satisfy the original criteria for public debt. Adherence to the fiscal rules was spotty (chart 1), with countries moving in and out of compliance. When the sanctions prescribed by the fiscal rules were suspended after France and Germany fell into non-compliance, the markets and government understood them to be guidelines at best, rather than binding rules. Even without fiscal rules, market discipline was supposed to be a failsafe, reinforced by the “no bailout” clause. But government debt that was treated differently before the euro area, as seen in the cross-country dispersion of bond yields, came to be treated nearly identically after its inception. While some interest rate convergence was expected, these nearly identical low rates came despite growing differences in net foreign asset positions of the euro area economies (chart 2). These largely reflected

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private sector debts, part of which ultimately was assumed by governments. So market discipline seemingly broke down. Or did it? Perhaps markets understood that the economic and financial integration of the euro area made it “too-big-to-fail”, so that the “no bailout” clause was not credible. At the height of the crisis in 2011, when there were real doubts about whether or not the euro area would survive, the dispersion of cross-country bond yields reemerged. But with this existential threat, the authorities acted to keep the currency union intact—the assessment that the euro area was “too-big-to-fail” was right. Behind the scenes, the build-up of private imbalances Given the political constraints and the risks as they were perceived at the time, Maastricht’s focus on the sustainability of the public sector and reliance on market discipline is understandable. But with the benefit of hindsight, it is clear that the framework neglected the risks associated with excess private sector leverage and divergence of competitiveness. The means to identify and address financial stability risks were not directly built in to Maastricht’s design. Looking back at the crisis, the role of private sector leverage has been significant. We know that countries with the greatest pre-crisis private balance sheet vulnerabilities have been the ones with the weakest post-crisis growth (chart 3a). Persistent current account imbalances were a signal of these vulnerabilities and underlying competitiveness concerns. For example, the higher the pre-crisis leverage of a country’s household sector, the lower the growth in consumption following the crisis (chart 3b). The story for corporates is similar, where there is a striking negative correlation between corporate leverage and future investment growth (chart 3c). And for banks, we know that those with high pre-crisis leverage have had to shrink their balance sheets. What’s more, we’ve learned that there is no simple separation between private and public sector balance sheets: private imbalances can eventually end up as public sector imbalances. This can happen either through a direct bailout of the banking system (Ireland) or the lost revenue and increased spending necessitated by deep and prolonged declines in output (Spain). Did Maastricht encourage private imbalances, making the crisis worse? Similar to fiscal policy, supervision of the financial sector and resolution of financial institutions under Maastricht, including lender-of-last-resort facilities, were kept in the hands of national authorities. However, unlike fiscal policy, there was no set of rules embedded in Maastricht to ensure a minimum degree of harmonization in the financial sector. Unsurprisingly then, financial regulations and market practices varied substantially across member countries. At the same time, the introduction of the single currency facilitated rapid financial integration, as reflected by a large rise in cross-border capital flows (chart 4). So when the crisis happened and the financial stability risks materialized, the result was pervasive and persistent financial market fragmentation in the euro area. This has led to unhealthy bank-sovereign links and an impaired transmission of monetary policy. All of this has weighed on the pace and strength of the recovery. Viewed from this angle, Maastricht‘s preeminent focus on fiscal policy has been limiting, both in the identification of risks and the effectiveness of the policy responses. 338

Policy progress, but not complete That being said, collective actions by European authorities have filled many of the gaps laid bare by the crisis, demonstrating a commitment to improving EMU architecture. Fiscal governance has been strengthened and rationalized with the Fiscal Compact, six- pack, and two-pack. Significantly, there have been encouraging moves towards a banking union. The unprecedented monetary policy response (e.g., LTROs, OMTs) has provided time to enhance EMU architecture. But despite these achievements, which have significantly reduced sovereign and corporate borrowing costs, key changes to make EMU architecture more robust remain incomplete, financial market fragmentation persists, and the recovery is weak and fragile. Looking beyond the crisis, has enough been achieved to reduce materially the risks of future private imbalances? We must acknowledge that no matter the architecture in place, identifying private imbalances ex ante will always remain a significant challenge, as will foreseeing the channels through which they are transmitted in times of crisis. And since fully insulating EMU against private imbalances is impracticable, improvements in the EMU architecture must aim to minimize not just their occurrence but also their scope for disruption to the economy. Moreover, for market discipline to work and play a complementary role, robust bail-in and burden sharing frameworks are necessary. Minimizing risks and dealing with the consequences if risks materialize Inevitably, crises will emerge, but by strengthening the common institutional frameworks and increasing the flexibility of economies, EMU will become more resilient. How can this be done? First, policies to improve market discipline should be put in place. This needs to be supported by clear rules for bail-ins, harmonization of insolvency regimes at the national level, and a Single Resolution Mechanism (SRM), with centralized powers to trigger resolution and make decisions on resolution and burden sharing in the financial sector. In this respect, the current lack of a common backstop—such as direct recapitalization of banks by the ESM—limits the credibility of the SRM and SSM. Without this, bank-sovereign links cannot be fully severed. A truly common backstop would reduce the fallout through the financial sector of any crisis and minimize the fiscal impact for any one country. Second, with the policies and structures just mentioned in place, especially an effective SRM, the Single Supervisory Mechanism (SSM) would be more credible. This would help ensure transparency and bolster confidence in the financial system. Together with strengthened macroprudential toolkits and structural reforms in the financial sector, these would reduce the build-up of private imbalances and the attendant risks to financial stability. Third, while the Macroeconomic Imbalances Procedure is a welcome process, it suffers from two shortcomings which need to be addressed: (i) it requires greater emphasis on emerging competitiveness gaps and corrective action before they translate into imbalances; and (ii) it currently lacks sufficiently strong corrective mechanisms.

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Fourth, deeper and broader capital markets are needed to diversify funding sources for firms. This would reduce their vulnerability by reducing reliance on the banking sector. To promote the development of such markets, concerted policy actions at both the euro area and national levels are needed to address regulatory, legal and structural hurdles. Fifth, provided that stronger fiscal governance is enforced, a shared approach with some elements of centralized fiscal policy would expand the scope of available countercyclical tools when national policies are constrained by limited market access or fiscal rules. This would avoid excessively restrictive fiscal stances during severe recessions and excessively loose ones during expansions. Sixth, to enhance growth prospects, there is a need to have a process that monitors and enforces structural reforms already agreed (Services Directive), and proactively advocates growth-enhancing reforms. Product market reforms that open up professional services, telecom, and electricity could provide an important boost. There is also a need to harmonize labor market regulation and facilitate much greater mobility of labor than is currently the case. Protecting workers with unemployment benefits and re-training rather than trying to protect positions through prohibitive hiring and firing costs would help get more people working. These would place the European economy on a higher growth path, helping to bring down elevated levels of debt. It would also make the economy more resilient to shocks, helping ease adjustment. Europe at the crossroads In the words of Robert Schuman’s 1950 proposal for a European Coal and Steel Community: "Europe will not be made all at once, or according to a single plan. It will be built through concrete achievements which first create a de facto solidarity." As bad as the crisis has been—and it has been extremely damaging with the crisis response far from ideal—one should not lose sight of the fact that Europe has responded with more solidarity and greater integration. If political will can be maintained, further integration coupled with steps to boost growth can create a more durable foundation for continued prosperity in the region. Chart 1

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http://www.imf.org/external/np/speeches/2014/021214.htm

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