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How Would The Euro Be Broken Up?

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Ambrose Evans-Pritchard writes about how the gurus nominated for the prestigious Wolfson Economics Prize discuss the breakup of the euro. First up is Neil Record from Record Currency Management.

“The consequences of a completely unplanned ‘Exit’ are likely to be catastrophic,” said Neil Record from Record Currency Management, one of the five qualifiers.

Mr Record believes piecemeal exits by one country at a time – the most likely outcome on current policy settings – would be “a recipe for continuous crisis”. There can be no such half-way house in any case. As soon as one country leaves EMU, the euro will lose its aura of inevitability. The charisma drains away.

He advocates a secret German-led “Taskforce”, with a French cameo role for the sake of “legitimacy”. Any broader planning would leak. The European Central Bank and the European Commission would be kept in the dark since they are “not well-equipped to design the demise of their own ‘great project’”.

“Failure to maintain secrecy would almost certainly lead to a complete freeze in the markets, making it impossible to finance eurozone member states’ deficits. This could accelerate a vicious circle … and possibly overwhelm the ECB. This is the stuff of nightmare,” he wrote.

The Taskforce would drop its bombshell on EU leaders on a Saturday morning. There would be a return to national currencies the same day. Any attempt to preserve a core euro would be unworkable since complex contracts worth hundreds of billions would leave a legacy of “ruinous litigation”, he said.

The only option would be to “force the legal frustration of all outstanding euro contracts” by abolishing the currency altogether. This would wipe the slate clean.

And what happens straight after it?

North European banks would face a brutal devaluation of Club Med debt. They would have to be recapitalized by their governments. The ECB would be shut down, with power reverting to national capitals.

Such a framework would allow Europe to “prosper again”. Foreign exchange markets would adjust “very quickly” once the boil was lanced. “Exit could start a new vibrant period in Europe’s history,” he said.

Then Jens Nordvig and Nick Firoozye from Nomura said

once the first state leaves EMU there will be a chain-reaction to Spain or Italy, causing havoc for currency swap contracts, and interest rate derivatives. “We believe that even if a break-up begins to unfold in an ‘onion-peeling’ fashion, it will eventually spin out of control and turn into a ‘big-bank’ break-up of the eurozone. An Italian default and exit would likely bring down large parts of the eurozone banking system.”

French banks would buckle, setting off a crisis that would push French public debt towards 120pc of GDP. “Capital controls would be a distinct possibility, at which point the euro would be obsolete”.

Mr Nordvig said policy makers must face the hard truth since credit markets are already pricing in a 30pc chance of Italy defaulting. “Euro adoption was supposed to be ‘irrevocable’, but the genie is out of the bottle. Foreign investors around the world, as well as institutions within the EU, are already trying to make contingency plans for a eurozone break-up. There is even evidence that some regulators outside the eurozone are asking banks to submit contingency plans for various eurozone break-up scenarios. Against this background, the cost-benefit analysis of planning ahead versus pretending that a break-up is not possible has shifted.”

EU leaders must spell out contingency plans right now to calm investors, above all by clarifying the jurisdiction of €14.2 trillion of debt. There should be a new European Currency Unit (ECU-20) ready to redenominate assets, if needed.

Catherine Dobbs, a former algorithms expert at Gartmore has a slightly different view on this

calling for a new settlement currency if the bloc splits into a hard core and weak periphery. Old euros and euro contracts would be treated equally. “There will be no impact on the solvency of financial institutions that have euro-denominated assets and liabilities that are unmatched,” she said.

Jonathan Tepper from Variant Perception said

Exit is the cleanest way to “re-balance Europe” and end the deflationary bias in the system. This may mean “crystalising losses” but they already exist in any case.

Mr Tepper said there have been at least 100 currency break-ups or exits over the past century, including the Austro-Hungarian union (the closest parallel), and Soviet, Czechoslovak, and Indian unions. They offer a roadmap of orderly divorce. The experience can be quick and liberating.

Devaluation episodes in Asia (1997), Russia (1998) and Argentina (2002) show the pain is sharp but short, followed by growth within two to four quarters. Dire warnings proved wrong in each case. Argentina rocketed back with 26pc growth over the next three years.

 

 

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Former Irish Leader Cowen Admits Euro Caused Irish Crisis and Blames Everything Else in Applogy

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Funny how the man who led Ireland into its crisis, Brian Cowen, choose Georgetown University in Washington DC to deliver a speech in which he apologise for the state he left the economy in. In it he blamed just about everyone he could, except himself. Cowen (former solicitor and politician since he was 24) was finance minister and Taoiseach(prime minister) from between 2004 and 2011 and was directly involved in almost all decisions which caused the collapse laid a lot of the blame on Ireland being in the euro. Below are excerpts from the speech given.

The creation of the single currency in Europe radically changed the financial environment. The elimination of exchange rate risk and the deeper integration of wholesale money markets in the euro area spurred huge cross-border flows of capital. Low interest rates in Europe — in part in response to sluggish growth in the euro area’s largesteconomy, Germany –encouraged large inflows of money into both fast growing peripheral economies in Europe and into riskier types of assets as investors searched for better returns.

…..

The view of most economists was that our growing balance of payments deficit was largely irrelevant, since we were part of a currency union.

He criticizes the design of the euro and how it didn’t suit the divergent economies.

the crisis also reflected a range of factors within individual European countries and with the design of the Euro. It is also important to recognise that Europe is a community of very different economies with great divergence in the strengths and weaknesses of individual countries. For example, Spain, Germany, Ireland, Italy, Portugal, Greece, and France all have very different problems and very different prospects.

There were many weaknesses in countries which was always going to end in trouble and risk was not assessed properly. These weak economies were constrained by the euro when global factors kicked in.

There were a range of differing domestic vulnerabilities in a number of European countries which were not fully recognised and which would have inevitably caused major problems. The crisis in the Euro was, however, the result of the interaction between the global market factors and weaknesses in individual economies. It was also inextricably related to structural issues within the Euro and when faced with the global crisis, these led to the near collapse of the banking system in many countries and a related sovereign debt crisis. At its core was a fundamental misjudgement of risk.

I like Cowen’s next analogy. That just about sums up the euro – “multiple plane crashes”.

In some respects the Euro crisis is like multiple plane crashes occurring at the same time where manufacturing design faults, exceptional conditions, pilot errors and mistakes by air traffic controllers all led to unexpected and disastrous results.

Cowen always had a great way with words, some might say he was great at bullshitting, not me. ;-). Anyway, on to the next piece of bullshit his speech where he talks about how he expected a soft landing for the economy.

Prior to the crisis, the overall assessment was that while there were vulnerabilities and risks, the central expectation was that there was likely to be a soft landing, a gradual slowing of growth and a belief that the banking sector had sufficient capital. At the time, I shared this positive view of the prospects for the Irish economy and this was a mistake. . With hindsight the resultant scale of the economic depression meant that the actions taken prior to the crisis to minimise potential vulnerabilities were in no way adequate and there was also a failure to understand that financial markets could be so unstable.

Thats just fucking hilarious. By 2006, 20% of GNP was based on construction and he says he thought there would be a “soft landing” and a gradual slowing. How can you have a gradual slowing when a property market collapses? Morgan Kelly warned about a massive collapse of over 50% which has since proved correct and still collapsing. Check out this clip from 2007.

We also know that Brian Cowen was continually warned. Check out this from a report by Canadian Rob Wright into how the crisis happened as reported by irishexaminerusa.

An investigation by Canadian expert Rob Wright, covering the years 1999-2008, shows that Department of Finance warned the previous government about the risks of a bubble, but it was ignored.

The Department’s advice was more direct and comprehensive than concerns being expressed by others in Ireland or internationally at the time.

Yet ministers around the Cabinet table continued to increase spending and cut taxes substantially above what the Department recommended.

The biggest surges in spending were during 2001 and 2007, in the run-up to general elections.

Cowen then goes on to talk about his bank guarantee scheme. What a stroke of genius that was ;-). Why guarantee Anglo Irish Bank when it had no dealings with the ordinary Paddy. It just leant to developers. That bank alone cost over €30 billion (only 1.8 million currently employed to pay this bill). He already had a guarantee on people’s deposits, he didn’t have to guarantee all bank debts. Knobhead.

Had we not guaranteed the funding of the banks, we faced the real risk of a run on the banks with devastating consequences for the availability of credit, the payments system, jobs, the economy and peoples’ savings.

 He pretty much admits he fucked up by referred to the subsequent Honohan Report.

The Honohan report on the banking crisis published in 2010 examined the guarantee in detail (one of the few studies to have done so) and agreed that an extensive guarantee was needed, but questioned whether the scheme was too broad. In particular, the report questioned the inclusion of certain debt instruments in the scheme, namely subordinated debt, or junior bonds, and existing long-term senior bonds issued by the banks.

The next line is just pure brilliant, because as far as I am concerned its bloody obvious Brian. I am just surprised that you didn’t bother to guarantee the US banks or even some more Euro nations debt you were that enthusiastic. Were you bought off or just fucking stupid? It’s a legitimate question. Last year alone in Nigeria €3 billion was given out in bribes. This week, a general in India claimed he was offered a bribe of $2.75 billion for military contracts worth €100 billion. Bribery does happen.

Whether a narrower guarantee would have staved off an implosion of the banking system at a lower cost to the State is a matter for economic historians to ruminate on.

Next he outlines how Ireland being in the euro meant we had to honour the senior bondholders and the bank debt. This enlightens us to why he guaranteed the banks. So this means if we weren’t in the euro we wouldn’t have to pay back all the senior bondholders or the bank debt. In fact we could have let Anglo go bust, merged AIB and EBS and get Irish Central Bank to lend to Irish Banks at 1% interest or buy 30yr bond from state at 1% as lender of last resort to capitalise the banks. Devalue the punt, loads of different solutions if we weren’t in the euro. Ah we can only dream of what could have been 😉  

Notwithstanding these legal issues, what the passage of time has shown is that, in reality, as a member of the euro area, the senior bonds of Irish banks had to be repaid in full, even if there had been no guarantee. At no stage during the crisis would the European authorities, especially the European Central Bank, have countenanced the dishonouring of senior bank bonds. The euro area policy of “No bank failures and no burning of senior bank creditors” has been a constant during the crisis.

The next passage was answered not long afterwards when we went to troika for a bailout because we went BANKRUPT anyway.

A question that is sometimes asked is why Ireland didn’t renege on the guarantee when the true scale of the banking losses became apparent. The reality is that the guarantee was enacted by Ireland’s parliament by a huge majority and reneging on it would have amounted to a declaration that Ireland was a bankrupt state.

He then talks of the interest rate of 5.8% our EU friends lent to us. It was pitched to the Irish taxpayers by Cowen at the time as a bailout but the rest of the EU was making a large profit on our misery. Why is the ECB lending to banks with a 1% LTRO when Ireland at the time had to pay interest 5.8 times higher. Well this is why.

It was, however, the best rate on offer at the time, as some Member States were anxious to dissuade countries from borrowing from the EFSF.

Yeah, so much for helping euro countries helping and how good was Cowen in negotiating that package? The reality was if the Irish banks collapse the contagion would probably have collapsed the euro and even though this was well know he obviously refused to use this when negotiating.

He points out that austerity which he undertook and the current government through finance minister Michael Noonan (former school teacher, yes I know, knows fuck all about economics) is also embracing means losing jobs and crushes ambitions.

While most economists accept the need for such adjustments particularly in small open economies, this adjustment means that people are losing jobs, that families cannot afford to maintain mortgages and that the ambitions of many have been crushed. The real costs of this adjustment is being borne by citizens in various EU countries.

While agreeing that austerity is killing us he still wants to sign up to the Fiscal Compact treaty which will bring in permanent austerity. (check out this post which outlines what the Fiscal treaty will do to Ireland)

The Compact is about returning budgets in member states to sustainable positions. As a member currency union that is something to which we should all subscribe.

Cowen even looks at the possibility of leaving the euro and talks about the need to “recognise the technical difficulties ” without even mentioning what they are. Well they are not that hard, first of all we left the Irish Punt and seamlessly joined the euro, so we did it already and anyway just ask Germany of their plans to do so.

From a practical policy point of view it is important to recognise the technical difficulties which would be involved reintroducing a national currency for whatever country might consider leaving.

More dumb musings.

Apart from the difficulties in leaving a monetary union and the absence of any directly comparable precedents, more fundamentally one has to ask whether the economic problems which would lead to a country leaving would be alleviated or worsened.

Hello, didn’t he just admit the euro was flawed from the start. Of course if a country left the euro, it could default and devalue, print money, determine its own budget, economic sovereignty etc. Anyway it is easy to leave the euro as Bloomberg reported last November of Merkel’s party passing a vote to allow euro members to leave the euro.

Cowen talk of the fiction that Irish banks are well capitalized. Did he miss economist David McWillams this week say that Irish banks are going bust again. What Cowen forgets is that when he capitalized the banks, he only covered losses on big developer loans. He didn’t bother about, small developers, businesses, buy-to-let and mortgage losses. The reason being, is he just bought time. He knew they would take longer to show up and would be massive and there was no way the troika would cover them up front.

The Irish economy now has one of the best capitalised banking systems in the world and an improved business environment and enhanced competitiveness.

Finally

It has world class infrastructure and a highly skilled population.

I think he meant Dublin has a world class infrastructure paid for by the rest of the country which was largely ignored apart from getting motorways, that only ran to Dublin by the way. Investment in transport around the country meant getting an extra bus, not trams, electric trains, stadiums or flyovers.  As for a highly skilled population, well most have them have already left on the emigration trail. 50% of people who lost jobs since 2009 have emigrated.

So there you have Cowen’s analysis and apology. So much for both ;-).

To put in context, Cowen never wanted a proper analysis or information to leak out about this period and it looks as if many documents were witheld or destroyed.

Despite long interviews with Brian Lenihan, the former Minister for Finance, and Brian Cowen, the former Taoiseach, the department said it had no records of what they thought. The department also claimed it had no record of what Kevin Cardiff, its then secretary general who was in charge of banking during the boom, thought.

Cowen was repeatedly warned by his department but choose to ignore the warnings. Incompetence or corruption?

The documents do, however, show that David Doyle, the department’s former secretary general, blamed his old boss Brian Cowen for not listening when he was Minister for Finance.

Doyle, who got a golden handshake of €575,000 on his retirement, said Cowen was told repeatedly in 2005/2006 that the economy had “dramatically overheated” and “the country was depending on unsustainable tax revenues”.

“The department did not agree with massive spending increases and made this clear to the minister. Political events had an impact on policy,” he said.

 

Sources:

  1. Brian Cowen – speech at Georgetown University 2012
  2. Morgan Kelly – The Irish Property Bubble – Causes and Consequences 
  3. Consequences of Fiscal Treaty on Ireland.
  4. German plans to leave Euro since 2009
  5. Bloomberg – CDU pass vote to allow euro member leave euro.
  6. Fatal guarantee by Finance was “heroic”: Hurley

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