The world financial instability and the Euro zone crisis - Chapter 4 Jacques SAPIR CEMI-EHESS

1. The world financial instability and the Euro zone crisis - Chapter 4Jacques SAPIRCEMI-EHESS

2. 4 Partial remedies

3. 1. The ECB new financing facilities. • A partial change in the ECB strategy. • An evolution toward non-orthodox policy tools was obvious since the end of 2007. • But the change implemented in December 2011 has been massive. • Is it the beginning of a new path or the end of the line? • But the Constitutional roadblock (The Karlsruhe Constitutional Court) is still in place. • The political opposition of the German government is much less a problem than it is though. • The Constitutional argument has been ignored so far and could be a major one.

5. The new mechanism and its assessment. • It works (at short term). • The REPO mechanism. • Liquidity flows (489 mlrd E and 529 mlrd E) • But, it is transforming now quickly the ECB into a kind of “bad bank”. • Why banks are taking back bonds they have bought to the ECB? • No improvements on the corporate debt market. • And, it is not solving the main issue that is the increasing weight of interests burden on budgets through the rise of interest rates. What is needed is not just a new liquidity facility but a massive reduction of the debt burden.

6. 2. The inter-governmental “agreement” of December 9th, and its uncertain future. • A common disciplinarian frame but no progress toward budget federalism. • Still no progress on budget transfers, and a German opposition stronger than ever. • The legal side of the agreement is to be murky (some countries are opposing it). • It is highly dependent of the willingness of national Parliament. • Political oppositions is now radicalizing against this agreement. • An agreement now partly emptied of its content through “Exceptions” clauses. • Several countries have made the case for exception on “exemption” clauses. • A possible conflict is coming with the ECB.

7. 3. Commercial banks response to the crisis. • Commercial banks are still engaged into a massive de-leveraging operation. • The situation of commercial banks is still very weak. • The uncertainty on banks is linked to the fact that nobody knows what is the scenario of the “next” crisis. • The EZ has accumulated a lag in bank regulations. • The impact on internal credit in different EZ countries. • The de-leveraging impact on internal credit and the coming European “credit crunch” (Corporate bonds are still at very high interest rates). • Uncertainty on assets. • The problem of regional banks in Spain and Germany. • A process of “re-nationalisation” of the sovereign debt is threatening to ultimately destroy the EZ.

8. 4. The Greek “controlled Default” • The mechanism of “voluntary” swaps. • The “old” Bonds and the “new” Bonds and the extension of the swap period (till May 15th). • -The actual interest rate and depreciation of the nominal value of the new bonds. (From 100 to 30 and from 4% to over 13%) • What impact on the Greek debt? • A reduction of around 100 Mlrd Euros amounting to 28,1% • At 124% GDP a 4% IR implies a yearly 5% GDP interest payment. • An end to the CDS market? • What future for this market? • What consequences are of disappearing CDS? • What is the current dynamic.

10. 5. A consolidation of a Ponzi scheme? • The Ponzi mechanism of the sovereign debt has not been modified. • Total debt x IR > real growth x inflation: automatic budget deficit. • The increase of the Debt/GDP ratio is now fostering high interest rates. • If governments want to reduce quickly this ratio they will induce a severe depression and then a drop in real GDP which is to destroy the debt reduction potential. • An internal Ponzi mechanism is now developing in Spain. • The central government has reduced subsidies to regional ones but regional government are increasing the size of budget arrears. • The central government will have to consolidate regional budgets. A 16% GDP deficit?

11. 6. What lies ahead? (a) The Euro zone recession and possible depression induced by austerity plans. • Strong depression in Greece and Portugal with large GDP drop (-7% and -5% respectively). • Deepening recession in Spain with a massive (24%) unemployment problem (-1,7% at best/-3,5% possibly). • Recession had already begun in Italy, Belgium and France • A future extremely uncertain till 2015. (b) Trade deficit reduction. • The increase of exports is limited • The severity of the decrease of internal demand: Greece (-40%), Portugal (-26%), France (-10%), Italy (-8%)

13. The severity of the potential Unemployment shock. Spain 29% (24%), Greece 52% (19%) Portugal 36% (20%), France 20% (9,7%), Italy 16% (11%) (c ) Short term possible catastrophe. • Greece: the controlled default as a partial solution. • Spain: the growing amount of unpaid bills by Local and Regional government (Catalunia 10Y = 9,56%). • Italy: The new government is more and more contested. A break-up of the Euro zone is now serious a possibility

16. 7. What consequences of an Euro break-up would be. • The International role of the Euro. • An asymmetric relation. • The reduction of “other currencies” share. • The Euro has still not achieved a dominant role versus the USD. • Would the USD predominance be strengthened by a collapse of the Euro? • There is already a process of “return to the USD”. • But fundamentals of the US economy are not good. • The collapse of the Euro could be the first signal of a general collapse of the International monetary system.

18. What could be opportunities for the development of regional reserve currencies (RRC) ? • The use of “proxies” for currency. • Gold. • Commodities. • IMF SDR • Current projects. • The Russian project of establishing the RR as a new RRC. • Latin-American projects (the Venezuela “SUCRE”). • The Australian Dollar. • What would be the future of the Yuan? • Would the “BANCOR” (Keynes, 1944) be the ultimate solution?

19. The Crisis in Western Europe is to be a long one. • It is to affect Central and Eastern Europe. • It will certainly have an impact on the Russian economy. • However, this could be the prime mover for: - A rethinking of the Growth path of Russia. - The development of new monetary instruments.