The three conditions for the ECB to cap spreads successfully: and why they will not be met

Adam Smith believed that it was part of human nature to truck, barter and exchange. I am not so sure that he is quite right. What I do observe, however, is that it is in the ‘nature’ of the ECB Council to dither, dawdle and evade.

Ever since this crisis began, the ECB has never lost an opportunity to be part of the problem. In July 2008, they… raised interest rates. A year later they sat idly by while Greece began the long walk up its own Golgotha, only to enter the fray in a half-hearted way when Portugal and Ireland seemed on the brink too. Their pathetic, heavily circumscribed, intervention in the secondary market of the fiscally stressed states’ government bonds was an example of how not to repress ballooning spreads within a currency union. In 2011 the ECB was the first of the major Central Banks to raise interest rates, after the loosening up that followed Lehman’s collapse. It proved, yet again, a particularly silly move. As if to add insult to injury, in July 2011 the then President of the ECB, the hapless M. Trichet, demolished the notion that it pays not to wager against the ECB by warning investors that bets on a Greek debt restructure will lose them money – a few weeks before Greece’s debt was restructured!

In view of this hideous track record, many rejoiced when Mr Draghi replaced M. Trichet, especially after the new ECB President famously unleashed his two-stage 1 trillion euro LTRO with which he bought 6 months or so of tranquility for the Eurozone’s politicians. Alas, the Eurozone was at an advanced stage of disintegration and throwing a wad of fresh loans at the insolvent banks could only go so far. Before long, Spain was in the mire and Italy began to feel the heat of insolvency. As the paroxysm of pessimism took hold once more, Mr Draghi made his famous declaration: “The ECB will do what it takes to save the euro. And, believe me, it will be enough.” While the markets reacted with restrained enthusiasm, everyone is now speculating as to what Mr Draghi is up to.

Der Spiegel seems to know what Mr Draghi is planning: a cap on the interest rates at which Eurozone member-states borrow or, at least, a cap on the spreads (vis-à-vis Germany’s bunds). If this is accurate, it constitutes a major step in the right direction, at least in terms of containing the debt crisis and buying time during which Europe’s leadership can, at long last, engineer a systematic solution to our systemic crisis. While I would be delighted if Der Spiegel’s story is born out by developments, I very much doubt that it will be. Here are some reasons.

That the ECB can, if it wishes, impose a ceiling on interest rates and/or spreads, there is no doubt. Just as the Central Bank of Switzerland imposed a cap on the franc’s exchange rate, in relation to the euro, so can the ECB implement an automated system that activates ‘buy’ orders for Eurozone government bonds whose yields climb above a certain level. For this to work, however, three are the conditions:

  1. First, it must be common knowledge that the ‘buy’ orders will not be discontinued before the cap threshold is attained. (Otherwise, speculators are offered a golden opportunity to beat the ECB at a game of its own design.)
  2. Secondly, the threshold for each member-state must be common knowledge. (Otherwise, much speculation and many financial resources will be wasted while the asymmetric information is turned symmetric.)
  3. Thirdly, there must be no conditionality. (Otherwise, speculators will place bets against the ECB’s automated purchasing strategy which will pay off if the said member-state fails to meet its ‘conditions’).

Since the crisis erupted, the first condition has never come even close to being met. ‘No Monetisation’ was, and remains, the crying call of surplus countries for whom the ECB’s greatest potential sin is to meddle with member-state interest rates (by employing its figurative printing presses). Let’s assume that the recent near-death experience of the Eurozone, following Spain’s and Italy’s travails, has changed the mind of the majority in the ECB’s Council, and possibly of some central characters in Berlin. I am not suggesting that this is what has happened. I am only prepared to go with this as a working hypothesis. Do the other two conditions apply?

Let’s cast an eye upon the second one: Is it possible to imagine that thresholds (and caps) are determined and made common knowledge by the ECB, in conjunction perhaps with the Eurogroup? To begin with, there is the question of whether the threshold will be the same across the Eurozone. Can we envisage an announcement such as: “From tomorrow, the ECB will ensure that no Eurozone member-state’s yields will exceed those of the German bunds by 3%”?

One has to state it to realise the kind of verbal storm that will hit Europe when arguments and counter-arguments start flying on how inappropriate it is to have the same cap for Greece and, say, Italy – or Ireland for that matter. It is a fair assumption, I submit, that if the ECB moves in this direction it will employ differential thresholds/caps. But, if so, who determines the differential between the thresholds? Will the ECB do this? Will the Eurogroup? Will the EU Council, at its monthly meetings, determine these numbers?

It is clear that neither Ecofin nor the Council can do this at the regular basis at which it will have to be made. And besides the fact that they cannot be counted upon to do this properly, our politicians do not have the remit to instruct the ECB on which threshold it should choose per member-state. After all, the ECB is supposed to be… independent. On the other hand, the ECB could certainly do this (from a technical point of view). But, if the ECB adopts this role, then it will have become the political overlord of the Eurozone, while lacking any semblance of democratic legitimacy.

It is clear that these thoughts are, indeed, exercising the mind of Mr Draghi and his minions. The result is confusion, dithering and a sad degree of inconsistency in their dealings. On the one hand, they tell us that it is up to Spain whether it wants help from the EFSF and the ECB. On the other hand, it is clear that the ECB has a track record of imposing (see Ireland) an acceptance of an EFSF program. It was, after all, only recently that the ECB told Italy that a series of austerity measures were the condition for LTRO help via Italian banks.

The ECB, in short, wants its cake and to eat it. It is jealous of its independence, pretends it is not in its remit to tell governments what to do and yet, in the same breath, selects measures that tie its monetary policy on the EU’s austerian mindset while dictating to governments fiscal terms and conditions before it flexes its monetary muscles in their favour.

Which brings us to condition 3: Suppose that the ECB commits to keeping Italy’s spreads to 3% or less. Suppose also that, as part of today’s dominant (austerian) paradigm, the ECB makes this commitment conditional on Italy respecting a (Greek-style) memorandum of understanding on government expenditure cuts and labour market reforms (to be assessed by the EU, the IMF, whomever). Suppose, lastly, that you are a speculator considering a wager against the ECB’s 3% spread threshold for Italian government debt. You know that if the ECB was unconditionally committed to the 3% spread target, it would be suicidal to bet against the ECB. However, if there is a significant probability that Italy will not meet the conditions that are part of its agreement with the EU-IMF-ECB, there is room for profitable speculation against the ECB’s 3% threshold. Which means that the ECB must choose between credibility toward speculators and credible conditionality of its threshold/caps. It is pure fantasy that the ECB can have both.


Markets are buoyant these days. This is so because of a powerful rumour that the ECB is about to cap Italy’s and Spain’s spreads. Such optimism is, tragically, unfounded on the facts and guaranteed to yield disappointment very soon. The three conditions that I outlined above, without which the thresholds will fail, cannot be met in a manner that is consistent with the currently prevailing paradigm. I wish they were. But they are most definitely not. Where does this leave us? The answer is: In a world where the ECB Council continue to dither, dawdle and evade. What will this mean in practice? At best, the ECB will step into the Eurozone short-term debt market suppressing the spreads in three month T-bills. At most, it will cap one-year bonds too, but in a manner that lacks transparency and long-term legitimacy. By enabling Italy and Spain to roll over their short-term debt, the ECB will buy Berlin and Brussels another six months or so. Just like it did with the LTRO. The difference, however, this time is the mountain of great expectations that Mr Draghi has created. When the markets realise how far short the deeds fall vis-à-vis the words, the ECB will discover that the Eurozone’s yields (which it wants to contain) have become more twisted than our politicians nickers. While ECB action will keep short-term borrowing costs relatively tight, 10 year bonds will diverge more than ever. In short, Mr Draghi’s “and believe me, it will be enough” is more likely than not to come to the same grief that M. Trichet’s “place no bets on a Greek debt restructure” did a year ago. Make no mistake: The Euro Crisis will not be resolved through the actions or decisions of the current ECB Council.


  • Printed out for further discussions. And like it seems to be in the big political business (Mister Samaras really thought it was wise to speak to german yellow press BILD these days and beg, exactly the ugly paper that started the ugly campaigns like Focus and to a lesser extent der Spiegel) – in these talks with many people, some with university degrees, some not, it always seems to be slightly similar. You feel like you’d be talking against a big wall. Some people seem to have decided to act and answer as if their brains would be walls. They can’t show you any good result, any success their political ideas and economic actions would have got us. Yet they somehow learnt to grin and feel like “we’re right, bud”. They seem to think their ways would lead to a success-in-the-end (for Germany, for Brussels, like you say.)
    Still, I can’t tell you how glad I am this blog exists.

  • Yanis, I hope you are right with your expectation that the ECB won’t start to cap the interest rates of nation’s bonds by unlimited bond purchases. This would be an invitiation to the markets to successfully speculate against the eurozone and reap limiltess profits.

    Especially since the conditionality in this sentence “However, if there is a significant probability that Italy will not meet the conditions[…]” is of course to be replaced by the reality.

    Beause if the costs for refinancing drops, the ClubMed governments will again go on a spending spree again instead of use the chance to restructure society and economy. Which is what they did during the defacto eurobond era between 2001 and 2008.

    • In the name of whatever you believe in, please stop. it is the ultimate way to address to a moron

    • That would be a bit more credible a concern if, I don’t know, the peripheral economies had actually gone on a spending spree in the 2000-2007 period (i.e. pre-crisis and after the Euro’s adoption). Which they largely didn’t.

      As per Eurostat, Spain’s deficit/surplus as a percentage of GDP went like this during said period: -0.9, -0.5, -0,2, – 0.3, -0.1, 1.3, 2.4 and 1.9%. Ireland did even better with 4.7, 0.9, -0.4, 0.4, 1.4, 1.7, 2.9, and 0.1% of GDP – it ran consistent surpluses.

      As for Italy, it ran deficits of -0.8%, -3.1, -3.1, -3.6, -3.5, -4.4, -3.4, -4.4, and -1.6% of GDP.

      What about Germany, that paragon of austerity? Well… in comparison with these Spain and Ireland, the German state spent like a drunken sailor: Its deficit/surplus data pre-crisis is as follows: In 2000, it had a surplus of 1.1% of GDP. Pity it didn’t last. During the period, that surplus was followed by deficits of -3.1, -3.8, -4.2, -3.8, -3.3, and -1.6% of GDP. Only in 2007 do we find a surplus of 0.1% of GDP. Germany, unlike, say, Spain and Italy, was never austere. In fact, it broke the Maastricht criteria for five years in a row, and during a period of economic expansion at that!

      Greece, on the other hand, was actually profigliate, with its deficit as follows: -3.7, -4.5, -4.8, -5.6, -7.5, -5.2, -5.7, and -6.5% of GDP.

      So, what does this tell us? That there is precious little correlation between who was profigliate and who is in crisis – that the crisis mostly caused the deficits, not vice versa. Spain and Ireland are in terrible shape, but the goverments were always thrifty. Italy is in better shape than Spain or Ireland, yet was far more profigliate. And Germany, for all its talk for austerity, never managed to be such, and is doing quite well.

      More importantly, it suggests that those sinful southerners will not immediately return to their immoral ways if the ECB intervenes – because they weren’t profigliate to begin with! Now, does the potential for abuse exist if the ECB intervenes? Yes, and over the long term we really should implement safeguards. But to say moral hazard and profigliacy are prime, or even particularly relevant problems at the moment, is quite delusional, and unsupported by data.

      In short, if this were a crisis of profigliate states, right now Spain and Ireland would be discussing how best to bail out Germany, not vice versa.

      Oh, and the data is here:

  • At the end of the day; we have no option other than to wait and see; to give the ECB the benefit of the doubt; to let them have their chance. We have to wait for their action; we have to give them the time.

  • Yanis – In a perfect world a cap on interests rates is obviously the best course of action. Unfortunately we do not live in a perfect world and a cap on interest rates is sure to lead to complete and utter destruction of the economies in the Eurozone.

    The reason is very simple.

    Spreads increase because investors believe risk is higher. If you cap interest rates 2 things will happen together which will rapidly implode the value of the Euro

    The first is that investors will simply not buy bonds if the yield is not high enough.

    And this will cause the ECB purchase the bonds itself.

    This will lead to hyper inflation.

    The interest rate must reflect the risk imagined by investors, whether it is realistic or not. That is the harsh reality of the situation, as much as we would love to believe the world should be “better” than this, it does not change reality.

    Alternatively, if not enough investors are buying, the ECB could suppress the interest rate to inspire confidence and demand for government debt, again causing hyperinflation through money printing.

    There is a reason that we can not stop road deaths. Everyone body knows exactly what needs to be done ie put airbags everywhere but the simple fact of the matter is that it is too expensive to do this. Unfortunately people die but that is the reality of the world we live in. Resources are finite and they have to be allocated in the way that is best for each individual and that can only happen through capitalism which involves letting banks and governments fail. If they are propped up by the people it will lead most of us into poverty.

    • Richard, you sound like Paul Ryan, the Republican VP nominee, with your predictions of inflation, and your nonsense about capitalism saving the world. You obviously need reminding it was capitalism that brought us to the brink of disaster, and only because the capitalists had captured govts that the people are being impoverished. You obviously don’t understand much about economic systems, particularly the capitalists’ greed for regulatory capture. Your Ayn Randian ideas come from pure fantasy, not from the real world.

    • Richard, here’s a former US Asst Sec of Treasury commenting on capitalism:
      “…At four of the world’s best universities that I attended, the opinion was that competition in the free market would prevent great disparities in the distribution of income and wealth. As I was to learn, this belief was based on an ideology, not on reality.

      Congress, acting on this erroneous belief in free market perfection, deregulated the US economy in order to create a free market. The immediate consequence was resort to every previous illegal action to monopolize, to commit financial and other fraud, to destroy the productive basis of American consumer incomes, and to redirect income and wealth to the one percent…”

    • David, to clarify a couple of points. Governments in bed with private industry is called fascism not capitalism.

      “capitalism that brought us to the brink of disaster” incorrect – derivatives based on cheap money brought us to the brink of disaster.
      The interest rates were/are a creation of private central banks who centrally control the economy – again fascism.

      Capitalism would have let the banks fail, socialism put the taxpayer on the hook for the losses of banks.

      “particularly the capitalists’ greed for regulatory capture.” – again, you are talking about fascism.

      I like Craig Roberts. “Congress, acting on this erroneous belief in free market perfection, deregulated the US economy in order to create a free market. The immediate consequence was resort to every previous illegal action to monopolize, to commit financial and other fraud, to destroy the productive basis of American consumer incomes, and to redirect income and wealth to the one percent…” – so he blaming capitalism here and in the same paragraph he explains how this is happening except he describes criminal behaviour and not a capitalist system. This is a common mistake.

      Capitalism can only function when there is a functioning legal system. Which there is not.

      Capitalism can only function when government is independent of business. This is not happening

      Real capitalism has nothing to do with government. Capitalism is the rule of law and people being free to do what they want as long as they do not restrict other people from doing the same. I fail to see the problem.

    • Richard, capitalism siimply doesn’t exist without govt’s supporting one form or another of the so-called “free market”. I grant your point that capitalism WITHOUT government might have something to offer the human race, but given the impossiblity of capitalism without govt, and the fact that it has never existed, I can only conclude you’ve bought into some kind of Randian faith based idea/s that do not correspond to anything in the real world.

      Sunday, 26 August 2012 13:02 By Lawrence Davidson, To the Point Analysis | News Analysis

      Part I – The Good Old Bad Days

      In the 132 years between 1797 and 1929, there was no effective regulation of U.S. economy. No federal agencies existed to control corruption, fraud and exploitation on the part of the business class. Even during the Civil War, economic management on a national level was minimal and war profiteering common. As a result the country experienced 33 major economic downturns which impacted roughly 60 of the years in question. These included 22 recessions, 4 depressions, and 7 economic “panics” (bank runs and failures).

      Then came the Great Depression starting with the crash of the New York stock market in 1929. This soon became a worldwide affair which lasted until the onset of World War II. Millions were thrown out of work, agricultural production partially collapsed, and the fear of rebellion and revolution was palpable both in the U.S. and Europe.

      It is to be noted that the way capitalism worked over these 132 years was a function of ideology. This was (and still is) the so-called free market ideology which taught that if the government was kept as small as possible (basically having responsibility for internal order, external defense, and the enforcement of contracts), the citizenry would have to pay very low taxes and be left alone to pursue their own prosperity. Thus, as the ideology goes, everyone would be free to maximize their own wealth and in doing so also maximize the wealth of the community as a whole.

      The Great Depression was a real moment of truth for the capitalist West because it suggested to the open-minded that the free market ideology was seriously flawed. Free market practices had brought the economic system to the brink of collapse, and Russia’s newly triumphant communists, espousing a command economy, represented serious competition. So the question that had to be answered was how best to modify the capitalist system so as to preserve the position of the ruling elite.

      It was President Franklin Delano Roosevelt who came up with an answer, at least for the United States. Through a series of economic and social experiments he crafted the New Deal and promoted the notion of the welfare state. It should be emphasized that this was not socialism. In essence, the New Deal was capitalism with safety nets and subsidies. It meant that some entrepreneurs in areas such as agriculture, defense, and other businesses, actually got money from the government to produce their products. On the other end of the spectrum, government money was made available to keep the really poor people from starving and the unemployed solvent while they sought new employment. A national pension plan was devised in the form of social security, and bank deposits up to a certain amount were insured. In addition, new agencies were created to monitor business activities, particularly the stock market and the banks, to prevent the sort of activities that had brought on many of the economic downturns of the past. This was a major step away from the ideal of a wholly free market but most of the citizenry, with the Great Depression at their backs, understood the necessity of the New Deal. Of course, taxes would eventually have to go up to help pay for it all.

      Part II – How Quickly We Forget

      Essentially, Roosevelt and the New Deal saved capitalism from itself. Left to those, such as Herbert Hoover, who could not escape the paradigm of free market ideology, capitalism in the U.S. may well have followed much of Europe in succumbing to the revolutionary movements of the right or the left.

      It has been 67 years since the end of WWII and during that time there have been 11 recessions impacting only 10 years of that timespan. Most of these recessions have been mild affairs compared to the 33 that came prior to the onset of the Great Depression, and the welfare safety net has helped the hardest hit to survive. However, since the 1980s, the U.S. economy has become more unstable and some of the downturns more severe.

      What of the steadfast adherents to the free market ideology? It would have been nice for the world if the Great Depression had put an end to them all–but that was not to be. For those who can understand things only with the help of rigid and all inclusive paradigms, ideology is what makes sense of an otherwise chaotic world. Ideology is also what defines good and evil for such minds. So it stood to reason that many committed free marketeers would retreat into a temporary silence and wait for a time to reassert their beliefs.

      It did not take long. In fact, counting from 1939 and the outbreak of the World War II (the event that finally marked the end of the Great Depression), it took only until 1980 or 41 years. That is two generations which is actually just about right. Unless purposefully passed on from one generation to the next, both skills and memories tend to dim and lose their meaning. So it has been with the memories of what unregulated capitalism cost the nation in the years before the New Deal.

      Why did things change for the worse in 1980? That was the year Ronald Reagan, a grade B actor and man of little intelligence, surrounded by neoconservatives and free marketeers, was elected president. Working within the context of generational forgetfulness, he set us all on a path toward deregulation and a resurgence of the free market ideology. It is to be noted that the country’s most recent recession (2007-2009) has been the worst of the post war era and a direct result of prior deregulation.

      We are still on that path and the living proof of this fact is that the Republican presidential candidate, Mitt Romney has just selected Congressman Paul Ryan as his running mate. Ryan is the Chairman of the Budget Committee in the Republican controlled House of Representatives, and author of a proposed federal budget that would slash social spending (and those safety nets) by some $3.3 trillion, ditch Medicare and Medicaid, while simultaneously cutting taxes for the wealthy. Ryan is no less than the reincarnation of a free marketeer who wants to recreate the circumstances that brought us all 33 major economic downturns crowned by the Great Depression. How quickly people forget.

      Part III – Social Darwinism As Well

      It was University of California Professor Robert Reich who recently explained what Paul Ryan in a position of real power would mean. “More than any other politician today, Paul Ryan exemplifies the Social Darwinism at the core of the today’s Republican Party.” And what is Social Darwinism? It is a belief in the necessity of a struggle for survival where only the “fittest” survive. Here is how William Graham Sumner, the 19th century’s leading American spokesman for this outlook, put it. “Civilization has a simple choice. It is either liberty, inequality, survival of the fittest or not-liberty, equality, survival of the unfittest. The former carries society forward and favors all its best members; the latter carries society downwards and favors all its worst members.” This may well be Paul Ryan’s version of the struggle between good and evil. By the way, liberty here is defined as the freedom of individuals to pursue wealth in an unfettered way.

      Following this ideology, a Mitt Romney presidency, with Ryan as VP, would most likely increase the pace of deregulation and destroy what is left of the country’s safety nets. It would ultimately devastate the middle class, greatly increase the ranks of the poor and unemployed, do away with union rights, and reserve prosperity for the upper class alone. All of this will be done in the name of the liberty. And, it will be guided by an ideological paradigm that has already been historically proven to be disastrous.

      We can speculate about popular reaction to these policies as time goes on. There will probably be eventual demonstrations in the streets. Those in power will respond with red-baiting tactics and repression against the protesting victims of their policies. Also, keep in mind that these ideologues will almost certainly bring us a new set of wars. And, as we already know, in wartime repression comes easier. If the electoral system works, those responsible should be cast out of office in four to eight years.

      All in all it is a pretty grim picture. It was George Santayana (1863 to 1952), a philosopher with both Spanish and American roots who said that “those who cannot remember the past are condemned to repeat it.” We in the United States, so thoroughly attached to our local here and now, are certainly candidates for this fate.

    • Hello David – Okay, the era pre US Central Bank and post central bank and completely different. Before the central bank competing currencies existed, with the central bank they were outlawed. There cannot be real capitalism with a central bank.

      About Rand, she had some good points. The most important one being that no human being should have the right to initiate force against another. Are you saying you disagree with this?

      “The Good Old Bad Days In the 132 years between 1797 and 1929, there was no effective regulation of U.S. economy. No federal agencies existed to control corruption, fraud and exploitation on the part of the business class. Even during the Civil War, economic management on a national level was minimal and war profiteering common. As a result the country experienced 33 major economic downturns which impacted roughly 60 of the years in question. These included 22 recessions, 4 depressions, and 7 economic “panics” (bank runs and failures).” – Lets say 1797 to 1913 for the reasons above. Despite all the problems, Americans went from nothing to being the 3rd richest people in the world. Are you saying that is a problem? Recessions are normal, bank panics are a symptom of badly run banks. The world is not perfect.

      About government being the answer to people’s welfare. There a simply way to test your hypothesis. Give the people with the least amount of money to ability to opt out of employment regulations, social security, socialised medicine etc etc in return for not paying any taxes.

      If nothing changes then you are correct, if people opt out, your hypothesis is incorrect. It is a simple enough experiment which would could be tested if government really had the interests of those least well off at heart.

      And best of all, from the government’s point of view, if those at the bottom of the economic ladder opt out it will save the government money. (If the government were to lose money by the poorest opting out then the government’s “welfare” system will be exposed as it will prove the poorest actually pay in more in taxes than they get out in benefits).

      Whatever the case may be net the government I don’t think it can be argued about giving the poorest the choice. And if you want to make it a bullet proof option, give people the option to opt back in if they do not like it, in other words things will return to how they are now, worst case scenario.

  • What’s the problem with the spread cap (if that indeed turns out to be the plan) being possibly only at the short end? The member states with problems need not issue long paper at all: there’s no rule of physics that says Italy or Spain must issue 10 year bonds, they could just fund 100% of their (new) debt with 3 month bills refinanced every 3 months, and they could do that for centuries if need be. Then the price of legacy 10 year paper on the secondary market is of no relevance whatsoever — and the whole existing stock is by definition gone in a short ten years anyway. From the ECB’s viewpoint, what’s the point of taking duration risk on top of whatever issues a cap would raise? It makes the dialogue between the ECB and member states more straightforward (the member state can’t lock in low rates and party wildly for ten years); and if a future federal institution takes over funding broke member states from the ECB, it’s better to hand over the tab without a funny term structure.

    (This is actually a general point, even in non-monetary union and non-crisis situations, should a fiat currency issuer sovereign issue long paper at all? It’s not obvious that such issuance is net positive socially.)

  • As for the speculators, their firing power is limited: all they can do to test the cap is sell the entire issuance of capped bonds currently in private hands to the ECB at the cap price. With the cap only at the short end, the amounts outstanding are pretty manageable. Besides the free float is probably only a fraction of the stock given that some of the private hands are effectively tied by political considerations or old habits.

  • Yanis, This post goes to the heart of how poorly thought out the design of the Euro Area was – and how much the powers-that-be refuse to accept the impossibility of that design working. Even your Modest Proposal, which is designed as a surplus recycling mechanism won’t repair the most important flaws you’ve made apparent above, much less cure the dogmatic determinism of the neo-liberals running the show to look outside their fantasied world view.

    From this morning’s Eurointelligence blog:
    FT Deutschland leads with the story this morning that a working group in the German finance ministry, headed by state secretary Thomas Steffen, is studying how to contain the costs of a Greek euro exit. The paper says that the preparations for a Grexit are much more concrete than is generally known. The paper gives no details of the work carried out, but says the group consists of ten finance ministry officials, which has been meeting regularly for some time.

    A week of high-level shuttle diplomacy kicked off yesterday with Francois Hollande’s visit in Berlin, which focused on Greece. At the joint press conference both leaders were trying hard not to say anything, which did not stop the media to quote them at length. Perhaps the most interesting development in Berlin yesterday was the statement by SPD parliamentary leader Frank-Walter Steinmeier that he favours to extend the Greeks by one year. Wolfgang Schauble, meanwhile, joined other cabinet ministers in ruling out a programme extension. as this would cost more money. That position is also supported by Jan Kees de Jager, the Dutch finance minister, who yesterday urged Germany to “stick with its strict position”, according to an interview with FT Deutschland. Reuters has also a revealing quote from a senior CDU Bundestag member who said he cannot imagine a change to the programme itself, but there may be some flexibility on the interest rates and the duration of the credit.

    Manfred Neumann is considering a German exit from the euro

    It is considered poor form among German academics to talk about a German euro exit, but Manfred Neumann came very close in an interview with Suddeutsche Zeitung. He first criticised Mario Draghi for being too political, spending too much of his time in meetings in Brussels. Then he went on to say that if one just looked at the figures, one could imagine a German exit. Germany has a large industry, which is focused on the global market, and Germany is always likely to diverge from the rest of the eurozone. He recalled that France proposed a German exit from the Exchange Rate Mechanism in 1993 for exactly the same reasons. The idea was only abandoned once the Netherlands and Belgium threatened that they would join Germany on the way out. Later in the interview he said he did not favour a German exit for political reasons (but his arguments suggest that he favours it for economic reasons).

    • All this is assuming a Greek government default on their official sector debt would cause a euro exit. Where is the institutional mechanism for that to happen?

    • The EZ seems like a circus these days, with the fat lady beeing the director. Except that the spectators are not cheerful but terrified that the fat lady will choose between them the one that willplay with the lion. What the don’t know is that she will command one at a time until they all “participate”.

  • Seems like this proposal by bureaucrats would actually function as a prelude to a collapse of the Euro. This structure they propose would be political in nature versus one based on the behaviour of an illiquid / liquid Market. But Yanis is pointing out exactly that. The scary thing is that the proposed setup could get out of control fast. What the hell on earth is keeping the European Markets together as we speak? Its a calm before the storm IMO.

  • Dear professor,

    I have always found your analysis and predictions very accurate, and i think NO ONE in this blog, even if he/ she disagrees with your thesis, can disagree with that.

    I would like you to comment two things,

    1. The TIME factor. Decisions made always late, on purpose as to worsen the bargaining power of the one that is beeing “helped”. We have seen this with Greece, now we see it with Spain especially. After that June EU summit when Spain got theoretically what it was asking for, M unpromised what she had promised, and put the blame on that court, which obviously had more serious business to take care of, so they promised a verdict after 3 months. Spain on the other hand honoured their agreement and took another huge dose of lethal austerity. Today 20 days before that verdict Spain welcomed the troika , which obviously means that when the verdict willcome out it will be almost useless.

    This is the most suspicious thing. It is like the Spaniards (like the Greeks before and i mean the governments) doesn’t seem to care, while all that is heard everywhere are the German yells.

    2. The role of the OTHER SURPLUS COUNTRIES. I think that Germany is making them spend their money “helping” the others in this abnormal (sodomistic) way, while Germany is getting the benefits. I think that is why they react this way.

    Thank you

    • Dear waves

      Two comments:

      Regarding your second point with the other “surplus countries” and how Germany makes them spend their money “helping” others, etc:

      The countries helping e.g. Greece include Estonia and Slovakia, both of which have a living standard way below what Greece has. That these brave countries were made to support Greece (and also Ireland which is super-rich from a Estonian and Slovakian perspective) is a scandal and absolutely appaling.

      The “true” surplus countries next to Germany (Netherlands, Austria and Finland) are quity wobbly in their support of the current policies. Please note that if they started to refuse taking on more risk to prevent the crisis countries from immediate financial collapse, it would get very, very difficult for the German government to convince the German public that without the Netherlands, Austria and Estonia, we will then have to just do it on our own. Also, brave and solidaric countries such as Slovakia and Estonia will not be able to continue with their support. That would mean that the likes of Italy, Spain, Portugal and Greece can start supporting each other. Good luck!
      I am aware that the damage to Germany if the Eurosystem collapsed could be huge. But please note that there are limits and these are not only defined by economic reason but also by the support of the electorate in Germany itself and that of other countries that seems not too certain at the moment.

      Secondly, one loosely related comment about interest rates in General. Let’s take Spain as an example:
      In July 2012, the 10 year government interest rate for Spain was 6.79%.
      That is not helpful for Spain, no doubt.
      But guess what the interest rate was before Spain joined the Eurozone, e.g. in April 1997, it was 6.95%!
      … and between 2000 and 2007, it was meandering between 5.76% and 3.05%. As we know now, that level of interest rate was a market failure and at least the 3.05% not at all reflecting the credit risk associated with Spain.

      I do agree that e.g. Spain needs some support and that probably, capping the interest rates through bold ECB action may be a good idea. But, just as a comment, the current interest rate for Spain does not seem excessive if viewed against past interest rates for Spain and in the light of the Spanish economy’s condition.

      Here’s some data on Spain and other countries long-term interest rates:

    • About your second comment Martin.

      Spain`s interest rate was higher then but they had their own currency so they could manage the situation.

      And could between 2003-7 there was no economic crisis.

      States are used to tweak their currency, Martin in order to be able to function, that means keeping their public service alive and whatever other needed by a state in order to function.

      Apparently you cannot do it according to the German values.

      So your comment was irrelevant

    • Waves – You say “States are used to tweak their currency, ” – so you are happy that a central planner can “tweak” the value of your property, your savings and your labour as they see fit? And even as it works against you?

    • You apparently cannot understand how important is for an individual the functioning of the state he llives in. You will understand someday.

    • Obviously an outsider cannot understand how much “tweaked” is the situation of one’s property in Greece right now. It is because of the central planner that we know all about.

      Tweaked out of science fiction.

    • Dear waves

      Concerning your comment from August 27, 2012 at 20:22:

      No doubt the fact that e.g. Spain is no longer indebted in their own currency that the Spanish central bank could in principle monetize / inflate away makes the debt burden now way more difficult to carry than a similar debt burden would have been in the 90ies.

      However, I just wanted to mention in my comment from August 27 that it is a little odd when there are statements such as “an interest rate above 6.0% is absolutely inacceptable” as Spain (and others) were used to those levels of interest rates before the Euro.

      Joining the Eurozone with the Maastricht Criteria granted them a leap of faith which brought interest rates down for Spain, Greece, Italy, etc.

      That was not a divine gift but a rational market reaction based on the assumption that e.g. Spain would become more like e.g. Germany in terms of economic policy (low inflation, low deficit). This assumption has proved wrong and now, the market reacts and roughly treats Spain the way it has always been treated before the Euro.

      Still, I believe the Euro in principle has some benefits (such as that it can overall bring interest rates down for all participants because it creates a huge area and a deep, liquid bond market). The same way the market got it wrong 2000-2007 (asking for too low interest rates for Spain) it is now getting it wrong the other way, asking for too high interest rates.

      With a little help from the ECB and internal reforms in Spain itself, they should be able to get through this crisis and in a year or two, things may look economically sound again.

      In that case, the market would react and Spain would be able to issue debt for way lower interest rates than at the moment. So I believe there is hope and the combination of short- to mid-term help from the ECB and structural reform in e.g. Spain that has a mid- to long-term effect can actually work.

      We are currently in the worst phase: The pain of the structural reforms is felt in Spain but the market has not yet factored the effects of the reforms in. In a year or two, this should change. The pain would hopefully get less extreme as the reforms have been implemented and the markets would gradually get convinced that Spain has put itself on a path to sustainable growth, with a more competitive, more export-oriented economy.

      This should work for Italy and Portugal, too.

      Greece is a different category but in principle, with a mix of fairly brutal reforms, short-to mid-term help from ECB etc and another debt restructuring should be able to get through and be in a better position than today in, say, two years from now.

  • It is ridiculous to stay together with a country that it tried very hard to humiliate us, to occupy us and dictate our economy and our way of life. Especially from a country that burned our houses, churches and schools, stole whatever came their way, newer paid anything for damages, the life lost and misery that they brought to our country.
    They misused the situation between the rivalry between the former Soviet Union and USA to use the people who they robed of their livelihood by destroying their property to rebuilt their country with the slave labor of their victims.
    The Greeks should work very hard to get Germany out of the Euro zone or to leave the Euro zone themselves.
    The Greeks however have a big problem, they think that the Germans are more honest than our politicians and the business elite for this reason they more or less are willing to suffer the humiliation of the occupation for a while. They will be deeply disappointed. The Germans are in our country again for the loot.
    Every German in any official capacity should be politely escorted out of Greece and told that he is not welcome.

    • Martin,

      I aggree that it was a scandal to put Estonia and Slovakia to pay for the South in this way, that was my point.
      Let’s not forget how Greek debt became unmanageable in 2008. The prime minister of that time came up with the idea of giving 32bn to the banks. I remember Sarkozy giving him congratulations in front of the camera for this pioneer idea. the debt automatically was raised by 10% og th GDP.
      This is what is happening since that time. And this countries now pay for the others by worsening their own economies, while Germany is dominating the PIGS. Let’s not forget the HELIOS program, and the privatisations that will take place in Greece. We will see who wiilbenefit from them.
      This whole thing is a mistake. I think the only viable way is what every fedreal government or everybody who participates in a common currency does: issue common debt. The modest proposal promises this without printing money, so it should do a far more better job than the one that is being done now.

      The path that everybody follows now, leads only to revolts, dictatorships and wars.

    • Waves – You say “This whole thing is a mistake. I think the only viable way is what every fedreal government or everybody who participates in a common currency does: issue common debt.” Why is it the only viable way?

      Local councils in Germany, Greece and the UK can borrow independently (and maybe more councils in other countries). To say independent countries cannot borrow independently under a common currency is nonsense. Independent local governments have being borrowing under a common currency long before the Euro was introduced.

      The common currency has got nothing to do with the problems in Greece, Italy or Spain.

      The problem in Greece, Italy, Spain, France is that they cannot devalue their currencies. This should be applauded as it limits the size of government by limiting their borrowing and therefore limiting the debt in the name of the citizens.

      It also protects workers and savers by maintaining their spending power.

      The only thing governments need to do is get their finances in order. It has nothing to do with the common currency.

      The common currency has simple exposed the theft of pensioners, savers and workers. The common currency is cold turkey and Greece, Spain, Italy are having withdrawal symptoms. Sometimes the medicine does not taste nice but it makes you better.

    • Dear Demetre

      Among other stuff you wrote: “They misused the situation between the rivalry between the former Soviet Union and USA to use the people who they robed of their livelihood by destroying their property to rebuilt their country with the slave labor of their victims.”

      What exactly is that supposed to mean? Slave labor to rebuild Germany? So after the war?
      I understand you don’t exactly like Germany but this really confuses me…

    • Richard

      Please bring data that proves that in the middle of this crisis indebted local councils are not funded by governmental mechanisms that are set in place for this kind of situation. That they are in danger of being expelled from their country if they ask for help from their governments.

      The problem with the common currency is that the countries that you mention cannot devaluate because of it…

      This situation guarantees that the Greek pensioners and gradually the rest of the workers and pensioners of EZ (including Germany) are left with no savings at all. Yannis here has discussed the imbalances that this situation brings. Try to understand why that happens.

      I am a pharmacist and I know very well how the medicines work. Also know very well what happens when you take the wrong one.

    • Waves – Evidence of local councils borrowing independently of government

      You said only viable way is too issue common debt, I am giving an example where debt does not have to be common for it to work in a single currency system.

      About expulsion, the only people talking about Greece being expelled from the Euro is Greek politicians and some EU politicians. Greece being “expelled” from the Euro is complete fiction. It is propaganda to make Greeks feel like children in the face of the “prestigious” & “powerful” European countries who know best. The purpose being to make Greeks feel dependent on the EU so they will bow to self destructive measures being imposed by desperate, insolvent international banks.

      The only way Greece will stop using the Euro is if the Greek government decides to stop accepting taxes in Euros. End of story.

      You say – “The problem with the common currency is that the countries that you mention cannot devaluate because of it…

      This situation guarantees that the Greek pensioners and gradually the rest of the workers and pensioners of EZ (including Germany) are left with no savings at all.”

      You are addressing two completely different issues as one and the same which is not correct.

      Yes, I said the countries cannot devalue their currency which means pensioners savers etc ARE left with savings, the opposite of what you said. If the countries COULD devalue their currency like they used to be able to, then yes, they would end up with a lot less.

      I don’t know how exactly you think pensioners and workers are left with no savings given this fact but let me hypothesise.

      You see the Greek government attacking businesses, workers and pensioners and this is what you are referring to. If so, this again has nothing to do with the Euro and everything to do with the Greek government being completely incompetent when it comes to managing the taxes they collect. It is that simple. And I take great care to separate the Greek government from the Greek people.

      About Yianis and the imbalances. He appears to be of the opinion that Greece is weak and that it needs charity from Germany in the form of money transfers to survive. I disagree completely. Greece is probably the strongest country in the Euro when it comes to natural resources, geographic location, the entrepreneurial spirit of it’s people, their education and the geography of the country itself.

      Greece should be the strongest country in Europe per capita (including Germany) and not the one with the beggars cup. You only need a basic understanding of the Greek economy to realise the enormous efforts that the Greek government goes to to bury the potential of such an amazing country.

      If Greeks had half the economic freedom of the UK it would be one of the leading forces in Europe if not the world.

      I have said before, to get a country like Greece into the trouble it is in, can only happen deliberately, even an incompetent could make a success out of Greece, it has taken real genius to create today’s situation.

      The solution for Greece? Voluntary taxation, the Greek government knows this which is why it is on an all out media propaganda exercise vilifying everyone for not paying taxes, even though they have NO proof. If they had proof they people would be taking people to court instead of slandering the Greek people via the Greek media (A media which is completely controlled by the unions, unions who have a vested interest in Greece being a dependent country so they maintain their power).

      Again, the answer for Greece is a system of voluntary taxation, that is the only way to keep the government honest.

  • Dear Martin
    The Germans during the war burned thousands of villages in Greece. Between those villages was mine village. They burned all the houses, the church and the school. They left only one house intact because they were billeted there. I was sitting in a pile of blankets before my grandfather’s house because we were ready to go to hiding and didn’t make it in time. First they killed my dog because it was barking, after that they just burned one house after another. To do such a distraction the Germans needed organization and structure. The knowledge learned in organizing such enterprises helped them in the rebuild of the country. We were left with nothing, absolutely nothing. The Germans until now didn’t pay for the distraction and theft.
    The USA needed Germany to be in between them and Russia. The Germans needed money to rebuild because they were hungry as Greeks were hungry. The Germans had the knowhow for organizing huge enterprises to supply the war and execute the war including burning. They were helped by allies, their former enemies.
    I don’t know if you are aware that many German ladies were willing to slip with enemy soldiers for almost nothing because they were in need. Some people call it a fear trade. I call it a form rape.
    The Greeks because everything was destroyed needed money; the Germans were needed cheap workers. Some people call it a fair trade, I call it slave labor. Yes both sides benefited from this exchange, but the Germans several times over.
    I calculated the price of the house and 67 years of no payment by Germans with 5% interest and the result is around thirteen and a half million dollars. I didn’t include any inheritance from my grandparents and my share of common goods. I didn’t include the loss of my enjoyment of my father because he was in the woods fighting the Germans. The Germans own me.
    By the way I like Germany. I don’t like only the Nazis.

    • Dear Demetre

      Thanks for elaborating. I can only emphasize that what Germans did in WW II was horror and included crimes, some of them on an unprecedented scale, that caused incredible human suffering.

      I know that and I don’t dispute it – and I am very grateful that Germany (oddly different than after WW I when it had behaved more or less like a “normal country” in such a war) was allowed to join the world community of nations again.

      Your maths may be right but I don’t think you can expect Germany to pay 13,5 million USD for your house.

      Whatever, I can understand your bitternis but think that we need to handle issues separately. What happened in WW II is luckily more than 67 years ago. Let’s not bring it up again as if it was yesterday. My generation of Germans (my father was 4 years old when WW II ended) won’t show much sympathy if they are thrown in one pot with the Nazis back then.

      If Germany needs to compensate Greece for damage it did or not is nothing you and I can decide. My gut feeling is that it is a little late for it and that it won’t promote peace and happiness between nations to bring it up now.

      Where do you draw the line – does England need to compensate India for exploiting it for centuries? Does Belgium need to compensate Congo? Does Russia need to compensate Poland and Ukraine for what it did between 1920 and 1950?

      These are difficult questions and I think the Euro crisis is not the perfect opportunity to sort this out, as tempting it must be from a Greek perspective. But if Greece wants to take Germany to court over it, that is fine. Maybe wait until you don’t need German good will anymore – just a friendly hint. You have waited 67 years – maybe you could wait another, say, 3 years before you go to court?

      By the way: My father’s house was burned down by the soviets and my ancestors were expelled (like millions of other Germans) because Stalin had decided to shift Poland a few hundred kilometers to the west. Made sense for him and was quite ok given what Germany had done in WW II.

      But it caused human suffering on a large scale – and in many cases people suffered that had little or nothing to do with the crimes Germany committed in WW II.

      Anyway: I believe we should learn from this and let wounds heal over. We should not forget but forgive. God, I was in Israel and people treated me nicely, it should be possible for Greek and German people to live together in the EU.

      Let’s not mix things – otherwise there is no way this will end in a nice way.

      By the way: The tone in the German media and from Ms. Merkel has changed slightly. I was under the impression a few weeks ago, that there was some kind of consensus that Greece is a hopeless case and has to exit the Eurozone.

      That sounds a little different now: Suddenly, it appears to me that Greece still has a chance and will be given additional support and time if it shows some commitment.
      I know this is hard but I would assume that if Samaras manages to cut the 11 billion EUR the Troika asks for, the money will flow in October. This would buy time and given that Greece has already restructured its economy (in a very painful way) and may even consider to implement an public administration (including tax authorities) that work, there would be real hope that the EU will not give Greece up.
      That, in my eyes, would be the ideal scenario in order for Greece to get out of this mess.

      Focusing on horrors from the past, as understandable as that is from your personal perspective, in my eyes doesn’t help. That would promote the picture (which is unfortunately a bit present in German media since this crisis erupted) that Greece tends to seek mistakes everywhere except in Greece. That, as you may imagine, does not go down too well in Germany.
      This is not to say you should forget your claims from the past. Pursue that if you want. But don’t bring it up in connection with this Eurozone crisis as if the two are in some causal connection.

      In case you mix the two, the German public would probably be quite hostile and have the opinion that we are being blackmailed by Greece exploiting WW II – may have the adverse effect from what Greece needs and desires.

  • I hope Germans are delighted with the backfire of their own decisions:

    German GDP components for 2012Q2

    The large fall in gross capital formation is striking, while household final consumption growth stalled to 0.8% compared with 1.7% during 2011 and 2012Q1. Exports were quite strong although the imports growth was low (especially compared with 2011 figures. Imports are now probably only fueled by export needs than domestic demand.

    Taking a look at growth contributions, consumption is back to 2009 levels while the gross capital formation drop led to domestic demand being negative by -0.6%. The worrying part is that the main driver of the drop in investment was the change in invetories of -0.9%, a figure larger than 2009. That can only point to a large risk of negative GDP readings in 2012Q3 when production and investment adjusts to large inventories. The major positive force was net exports with a 1.1% contribution (making the GDP growth positive). Since a large part is attributed to lower imports (which are driven by weak domestic demand) and the global macro outlook (especially in China) is negative, the foreign sector will probably not be able to support German in the second half of 2012.


  • Of course the caps should be the same for all countries. Say you cap Greek and German yields at 6%. Since the market is far from demanding 6% for German bonds, this means you don’t buy any German bonds. But you would if it did.

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