sábado, novembro 09, 2013

Draghi, deflation, dichotomy in the Eurozone

The Eurozone financial crisis is now 5th, or 6th year, depending on who's counting.
But remmember that "+2-2=0", "+12-12=0", and  "+20-20=0" so an overall "equilibrium" can hide a lot of pain and a lot of gain

But equilbria are not all alike, especially in a Single Currency Zone given the absence of the necessary adjustment mechanisms.    If a "+2-2=0" situation can be seen as routine, a  "+20-20=0"  situation is  a unmitigated disaster and sign of severe regulatory and market failure as rebalancing adjustments are pushed too far into the future.

So the the ECB's determination to overcome financial grid-lock in Europe is commendable, but not necessarily effective , because it does not necessarily promote the painful but necessary adjustments among both creditors and borrowers.

The ECB has been "doing all that is necessary" by 
(a) making funds available to net borrowers so they can repay their creditors  and 
(b) keeping short term Euribor interest rates low and now lower, with the cut from 0.5% to 0,25%.

Failing to put itself in the shoes of the net borrowers, the  ECB also sees deflation as a potentially good thing. Yes, if your incomes are steady or growing,  with lower prices "you can buy more stuff", but this  just shows  lack of appreciation for the divergence or dichotomy of fortunes within the Eurozon,  which is worrying in an European institution.  Price deflation can be a good thing, unless the "price" that is being deflated is your salary.  Lower short term interest rates provide some debt relief  for variable rate borrowers (such as housing mortages in some countries), but not for Goverments who generally issue fixed rate bonds.

And the ECB emergency funding, such as the 3-year LTRO launched in 2011,  has not protected banks in net borrowing countries from the ravages of asset impairments and loan losses as local borrowers weaken further and further in real terms. Greek banks continue to rely on the ECB to fund 18% of their assets, Portuguese banks 10% and Italian banks 6%.  The interest rate cuts may help to soften the blow of the stress tests scheduled for 2014, but just a very little bit. 

The recycling of funds from the ECB to the local banks  to international creditors, including the EIB, can be seen in the following example.  The EIB financed up to 50% of one (or several) toll road concession 10-15 years ago. Being very risk averse,  it provided only the funding and it required a payment guarantee, on first demand, covering principal, interest and eventual penalties, from a bank syndicate including local banks. A decade later, the economic disaster shrunk traffic to 30-50% of the original traffic projections, making a mockery of the original traffic due diligence, including that of the EIB.  Because the EIB did appraise the traffic studies thoroughly, even though it was protected from the traffic risk by bank guarantees from top rated banks.   

But local banks have been on the front lines of the econmic crisis.  As their bank credit ratings collapsed,  the EIB called on the local bank guarantors to cash collateralize the payment guarantees,  for those PPP projects which the EIB analysed thoroughly.   Having lost access to the interbank funding market, Portuguese banks had to draw funding from the ECB (in Frankfurt) to place on deposit with the EIB (in Luxembourg), and thus to protect the EIB's  AAA credit rating.  

This "passing the euro" of loan losses keeps everyone very busy but it is less than "kicking the can down the road", it is kicking the debtors when they are down.  The dichotomy or divergence of fortunes within the Eurozone continues to increase, and so do the risks. 

Counting the crisis years from the perspective of  Greece, Portugal and the other net borrowing countries:   The Greek  economy has shrunk 40%, unemployment may be "easing" to 27% but the hidden misery has certainly not hit bottom.  Internal deflation is said to make the over-indebted  Greece economy more competitive (sic), the sort of mistaken economic analysis that has brought us to the persistent crisis, as some analysts point out.  If you can reduce your costs you can compete better, yes, but if you are over-indebted reducing your income will increase your real debt burden. Unless your creditors take some of the loss through debt forgiveness or very low interest rates and long repayment periods, as in the Debt Jubilees of biblical times.

Putting an end to the debt spiral is impossible if the creditors are protected from suffering losses from their bad credit decisions.  

Germany Current Account to GDPCounting the crisis years from the perspective of Germany and other net creditor countries:  Germany's export machine continues to produce record surpluses, in general, but also in the Eurozone. We can't fault the German for their selling prowess, unless they push exports on unsustainable credit or even  bribe the buyer.  But we can say that high and rising trade surpluses are unsustainable and are moving in the wrong direction.  And there will be hell to pay sooner or later,   probably by the borrowers and the weaker trading partners. Or is there no limit to sustainable divergence

A dangerous case of when good news is bad news. 
Mariana Abrantes de Sousa 
PPP Lusofonia

Debt jubilee
Greek deflation
ECB cut highlights Eurozone dichotomy
Bank asset impairments
ECB-LTRO keeps money flowing back to foolish lenders
Germany in new trade record
Defence procurement