Archives for posts with tag: Eurozone

Government Debt and the Economy (very wonky and graphy)

05/24/2013 //
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Hi again, it’s been too long. I’m starting to make a habit of apologizing at the start of each new blog; I think instead of doing that I will just try to update this more often. While you may not have enjoyed my 3,000 word wall text about the New Year last time, you’re sure to enjoy this blog about government debt! And while this blog is very similar to some other posts I’ve written in the past, I think it addresses some important newer information. In a way I will be piling onto an issue and a paper (more specifically) that has already gotten much attention. The Reinhart-Rogoff research paper has been refuted for its macroeconomic theory by Nobel-winning economists and for it’s specific (excel-related) errors by grad students, even Stephen Colbert piled it on eventually. While opinions on the paper vary, no one can dispute it’s significance in framing the debate for policymakers from across the world. Others have already thoroughly refuted the paper’s conclusion, so I won’t try to do this directly. Instead, I would like to look into some of the broader questions that are raised in this paper; specifically, what is the relationship between government indebtedness and the overall health of the economy. 

To begin, I want to briefly explain the paper’s thesis and how it’s been refuted. In 2010, Carmen Reinhart and Kenneth Rogoff of Harvard authored a paper titled “Growth in a Time of Debt” that argued that after a certain threshold of indebtedness (90% of GDP) a nation’s growth will drop off dramatically. Underlying this claim was a statistic stating that average GDP growth in developed countries with 90% public debt to GDP will see GDP growth of -0.1% on average. The pair refused to release their data to others until a grad student at the University of Massachusetts, Thomas Herndon, was allowed to use it for a term project where he intended to replicate their findings. Instead, he found that their excel spreadsheet had somehow omitted the results of  five countries and incorrectly averaged New Zealand’s GDP growth. When those countries are taken into account, particularly Australia (!), Belgium, Canada, and New Zealand, Thomas found that average growth for countries with 90% debt to GDP was actually 2.2%, a very different result than -0.1%! Now, instead of chest thumping this news that broadly confirms my own interpretation of recent history, I’d like to dig deeper into the broader question raised by the Reinhart-Rogoff paper: what effect does high government debt have on the economy? 

Before touching on any further numbers I’d like to briefly explain some terms I’ve used to get at the heart of what is being debated. GDP (Gross Domestic Product) is a nation’s total economic output (consumption+investment+government spending+exports-imports); this is the most common measurement of the size of a nation’s economy. Measuring government debt to GDP then is a way of comparing the size of a nation’s debt versus it’s entire economy. Economists prefer this measure over total debt amounts because it helps express the relative size of a country’s debt. With that said, here are two modern examples of the metric Reinhart and Rogoff explored and their divergent conclusions:

japanese debt and gdp growth 2008 2012 Spanish debt and gdp growth 2008 2012

Both Japan and Spain have received a lot of media coverage lately for their economic circumstances, specifically their indebtedness. But as you can see in the graphs above, their levels of indebtedness do not correlate to growth with any consistency. Japan’s level of debt has remained above 100% of GDP since 1998, it’s economy has grown at an average rate of 0.55% annually. While that number looks quite weak (it is), it occurred during: the 1997-8 Asian Financial Crisis, the 2007-8 Global Financial Crisis, and the 2011 Tohoku Earthquake and Tsunami. Even with all of these headwinds the Bank of Japan predicts annual growth to be 2.9% in 2013. While Spain’s pre-crisis growth was higher than Japan’s, its much lower levels of indebtedness have not shielded it from the stagnation being felt throughout much of the Eurozone today. To further illustrate this, lets take a look at another useful economic indicator: unemployment rates and levels of indebtedness.

japanese debt and unemployment rate 2008 2012 spanish debt and unemployment rate 2008 2012

As you can see, despite relatively low growth and high levels of government debt, Japan’s unemployment is considerably lower than Spain’s astonishing rate; one in four Spaniards were unemployed in 2012 (currently it stands at 27.2%). If you’re thinking, “hey, Spain is very different from Japan, there’s more to the story than this” then you’re on to something. The problem with Reinhart and Rogoff’s conclusion (aside from its Excel errors) is that its simplicity obscures larger questions about debt and the economy: there’s more to it than “big debt bad, small debt good.” I want to explore what other factors are at play between public debt and the economy in the remainder of this post. There are several areas of concern that economists look at when it comes to public debt, many of these ultimately derive from one issue: borrowing costs. The short answer to why Spain has relatively little debt yet still faces economic headwinds is because it has had to borrow money at high costs in recent years. This cost is measured by the yield that is paid by Spain to buyers of its government bonds, like an interest rate (%) paid on a private loan. While Spain has seen its borrowing costs improve this year, it faced years of high yielding bonds before: Spanish borrowing costs 3year

Years of high borrowing costs have done more than just complicate the finances of Spain’s government, it has found its way into the real economy as well. Spain is an example of what can happen when a country’s debt is not denominated in a currency that is controlled by the debtor nation’s central bank. Under normal circumstances (i.e. when a country borrows in a currency it also issues) a central bank has flexibility when it comes to both controlling a nation’s borrowing costs and shielding the economy from its harmful effects. For example, the central bank for the UK (the Bank of England) has used its power to both lower the yield on long-term government bonds (by purchasing them with printed money) and lowering interest rates (0.5% since 2009) to try and boost available credit in the real economy. In addition to these tools, central banks like the Bank of England have also intervened at times to lower their currency’s exchange rates with other countries. Without these options, Spain has instead had to rely on the policies of the central bank for the Euro, the ECB, with limited success. 

The ECB dropped interest rates to 0.50% earlier this month (from a previous 0.75%) yet these rates have not translated into lower borrowing costs in Spain (among other countries). Instead, banks in Spain and other “peripheral” Eurozone countries like Italy and Portugal have had to pay more, in line with their government’s own higher borrowing costs. This, in turn, has translated into higher borrowing costs for Spanish and Italian businesses and decreased business lending overall: 20130504_FNC549
(Source: The Economist)

As you can see on the above graph, borrowing costs for Spanish and Italian businesses and the overall lending environment have fallen out of sync with ECB lending rates. The message I want to convey here is not that Spain’s economy is doomed to failure; Spain’s circumstance has actually improved somewhat recently. Instead I want to point out Spain’s high borrowing costs had nothing to do it’s government’s debt levels or deficits; before the Global Financial Crisis, Spain ran a budgetary surplus and had relatively little debt. So why has Spain been punished with high borrowing costs while countries with much larger debts (Japan and the US, for example) have not? The answer, as well as a new set of problems, come with control over the currency that debt is denominated in.

Something that astonished me when I first wrote about debt in the US two years ago was how low Japan’s borrowing costs are compared to its high debt:

Japanese debt and borrowing costs 2008 2012 spanish debt and borrowing costs 2008 2012

Despite it’s astronomical levels of debt, Japan has been able to borrow at remarkably low rates in recent years, much lower than Spain even in 2008, years before Greece would seek a bailout. Even when you compare Japan to other countries that issue debt in their own currency their rates seem quite low. Fortunately, there are very smart people who write about these things who have explained the situation for us. Essentially, through a mixture of Financial Repression by the Ministry of Finance and a willingness by Japanese households to put their savings into government bonds, rates have been kept quite low. But all is not well in Japan with this arrangement, as Noah Smith points out:

… it seems to me that the Japanese government’s success in holding down its borrowing costs has probably had big negative effects on the economy. Banks that are forced to buy JGBs can’t lend as much to firms, which seems like it would depresses economic activity, holds down growth, and probably contribute to deflation via suppressed wages. Households have been squeezed and squeezed by falling incomes until their savings rates have gone negative, yet they are still earning nothing on their savings.

In most countries we don’t think of deflation as a problem, but it can be just as damaging to an economy as inflation. Deflation, which Japan has experienced for most of the past decade, makes private borrowing more expensive, and pushes down consumption and investment over time. This has become a big enough problem that Shinzo Abe has implemented aggressive monetary and fiscal policies that are designed to increase inflation and decrease the value of the Yen, with mostly positive results so far. But Japan is unique in this regard: many countries fear the opposite when regarding inflation at a time of high debt.

argentina inflation

(source)

Argentina is a useful example of both the benefits and the pitfalls that come with controlling your own currency. From the 1970s to the early 1990s, Argentina suffered a series of currency shocks and generally high inflation, culminating in a spectacular 5000% annual inflation rate in 1989 (pictured above). That crisis was sufficient enough that Argentina began a currency peg with the US Dollar in 1991; under the new regime, anyone could exchange one Argentine Peso for one US Dollar. To maintain this “convertibility”, the central bank of Argentina had to maintain an equal amount of US Dollars in reserve as there were Pesos in circulation. While this had the positive effect of limiting inflation and increasing foreign investment in Argentina, it had many negative effects as well. 

By tying the value of the Peso to the USD, Argentina effectively ceded its monetary policy to the US Federal Reserve. In addition to receiving the low inflation of the US Dollar, Argentina experienced the pitfalls of its high value: for the duration of the currency peg (1991-2001) Argentina’s current account (net trade and net investment) was negative. Unemployment started to increase as the currency’s high cost made difficult for businesses to pay living wages while remaining internationally competitive. By 1999, the unemployment rate reached 16% and the economy entered a three-year recession as Pesos and Dollars became scarce. At the same time, the government faced pressure from the IMF to lower its deficit with spending cuts, which it implemented to the detriment of the economy (sound familiar?). Argentina was forced to borrow at high interest rates before being shut out of bond markets entirely. With debt levels reaching 164% of GDP in 2002, the country defaulted on most of its debt and abandoned the currency peg  shortly after. By devaluing its currency and effectively ignoring calls by the IMF for further austerity, Argentina was able to recover from the crisis with average growth above 8% since then. The downside to this recovery has ironically and not entirely unsurprisingly been a return to higher inflation levels. 

Perhaps out of fear of the panic and political upheaval that precipitated the economic crises in 1989 and 2000, the Argentinian government has consistently underestimated official levels of inflation since 2007. This is best demonstrated by the average change of prices found online, which has been aggregated by groups like PriceStats; this index shows inflation for 2012 to be ~10% higher than the official figure of 13%. Inflation has become such a hot button issue there that when an interviewer pressed the economy minister on the matter he abruptly ended the interview. But does this high inflation have a relationship with the size of Argentina’s public debt? 

Surprisingly, inflation in post-crash Argentina hasn’t corresponded with higher debt levels; even when you factor in higher inflation after 2007 there is no relationship between debt levels and inflation rate:

argentina inflation vs debt

(source)

Yet while Argentina’s inflation might not directly correspond with debt levels, there appears to be a connection between the fiscal and monetary policies of president Cristina Fernandez de Kirchner, including her management of the national debt. Perhaps most importantly, by using the central bank’s reserves to fund domestic spending, the government has removed an important guarantor of both currency stability and low inflation by removing the central bank’s independence.

At times, writing about these countries felt a little like writing Isaac Asimov’s A Choice of Catastrophes: is the world really this unforgiving when countries accumulate large debt? Judging by these three very different examples you might conclude that we are faced with three awful choices: crushing austerity (Spain), financial repression and deflation (Japan), or runaway inflation and dishonest institutions (Argentina). In truth, these are all extreme examples that I used to drive home a few points.

Firstly, if a country’s debt is not denominated in its own currency it runs the risk of defaulting on it’s loans, just like a private borrower runs the same risk. Conversely, it is difficult (perhaps impossible) for a country to default on its debt if it is denominated in its own currency. With this in mind, the risks of high levels of debt to a nation’s economy vary considerably depending on whether a county’s debt is denominated in its own currency or not. For countries with debt in a foreign currency, (the Euro counts in this case) the risk of actual default makes austerity much more likely and therefore the greatest risk of high debt levels comes from these possibilities. For countries with large debts denominated in their own currency the greatest threat to the economy stems from the effects of their own government’s actions directed at controlling the debt. This can come in the form of inflationary policies as in Argentina or in financial repression as Japan has employed.

So where does that leave the rest of us? What, for example, should the US do in response to it’s high levels of debt, currently exceeding Reinhart and Rogoff’s deadly 90% threshold? In reality, it’s not impossible for a nation to climb down from high levels of debt as long as a few things fall into place, if history is any guide:

historic us debt

Looking the above graph, one could imagine the extraordinary fiscal tightening that the US had to manage after World War II to eventually get debt levels from 120% of GDP in 1946 to just 31% in 1975. What might be surprising to some is that the United States almost never runs a budgetary surplus, even when debt levels have been very high: 

deficits cbo slide

(Source)

While there have been some periods of budgetary surplus, (eight in total before 1998) the overwhelming majority of the past 70 years has been spent in the red for the United States Treasury. How does this square with debt levels that remained low, or have fallen for long periods of time? The answer comes from a few factors that one might not consider at first when looking at government debt and spending (Krugman explains this in depth here). The two most important of these are the effects of economic growth and inflation on government debt. Say the government owe $1,000 in 10 years, and the average inflation for that period is a very acceptable 2.0%, and at the same time the economy grows at an average rate of 2.5% (the long term norm for the US economy). In ten years time, that debt would shrink by 45%, to a mere $550 relative to the rest of the economy. This is why during the 1990s the US debt to GDP level shrank even before the government ran a surplus:

us debt to gdp 1990s

(sources I used)

Essentially, if an economy can maintain average levels of growth, (say 2.5%) and average inflation (~2%) then government debt will decline as long as deficits do not exceed this combined total (in this case ~4.5%). This holds true in more than just the US case:

australian debt

historic australian deficit surplus

To summarize some points: high debt levels certainly have caused some serious problems for many economies, BUT these problems appear to be much more manageable when the debt issued is under a local currency. And while the high debt levels in the United States and other large economies might appear impossible to repay, equally large debts have been repaid in the past without default or high inflation being part of the outcome. I hope you enjoyed reading this blog as much as I enjoyed writing it, until next time.

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Austerity and European Democracy.

05/17/2012 //
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It only takes a cursory glance at the global press to see how the recent European elections have been viewed:

I don’t really have to translate der Spiegel to get the message across but it says: Why Greece must now leave the Euro.

Wow. So France elected a “dangerous” Socialist and Greece is going to leave the Euro. Not only that, the markets apparently believe that the sky is falling as well: (links here)

To summarize broadly the narrative that has come out of the press in the past week: European voters have rejected austerity, now the end (of the Euro) is near.

I want to go beyond that narrative though, there’s much more behind this “democracy interferes with a solution to the European crisis” than is being reported.

So lets start with the election of Socialist François Hollande. The Economist is a publication I hold dear most of the time; usually their articles promote a mostly centrist, albeit pro-globalization view. But there are so many problems with the Op-Ed piece on Hollande that I struggle to find merit in any of it. They malign him for not seeking to trim the size of the French state, while admitting that he seeks a balanced budget. And while they say that he “gets one big thing right” with his criticism of German-let austerity they posit that he isn’t doing it for the right reasons, as if intentions make a difference in modern electoral politics. (I’ll go into more detail on the German austerity program but to avoid being redundant here’s a relink a blog I wrote about it earlier). So The Economist was alarmed by the prospect of Hollande winning, what about the markets?

As you can see yields on French 10-year government bonds initially dropped before rising later in the trading week. But even at its current peak French bonds are still more highly valued than they were for most of the end of Nicolas Sarkozy’s term, a less “dangerous” candidate.

But while Hollande’s ascension might have drawn criticism of The Economist, Greece’s electoral result was far less conclusive. While people viewed the Socialists rise with ambivalence, almost everyone has taken the Greek result as a sign of the volatility. From the BBC:

New Democracy was awarded 50 additional seats for coming in first place, but no party won even 20% of the popular vote in this election. It should also be noted that only PASOK and New Democracy supported continuing the bailout-induced austerity program. After four separate attempts to form a coalition, the parties gave up and planned a new election on June 17th. Current polls have the left wing anti-austerity party Syriza coming in first place with 22% of the vote.

While the potential for a Greek government that opposes austerity has rattled the markets, people should be equally concerned over what the response could be from Germany. Angela Merkel telephoned the interim leader of Greece and was reported to have suggested Greece should hold a referendum on its Euro membership, though Germany denies this was proposed. Greece would not be alone in seeing voters reject austerity: Italian local elections also saw supporters of austerity get voted out. And while not facing an election, Spain’s prime minister Mariano Rajoy said that the country would breach the deficit targets imposed by the so-called Fiscal Pact led by Germany.

I’d like to expand the often cited “fiscal pact” for a moment here. The EU treaty now called the fiscal pact was signed at the beginning of March 2011, it stipulates that signing nations must not run a budget deficit of more than 3% of GDP or they will be fined. The fiscal pact has been maligned by many (Joseph Stiglitz even called it a suicide pact) but the treaty was enacted in order to fix a real problem inside the Eurozone.

Unlike the United States, where both our currency (monetary policy) and the national budget (fiscal policy) is set by the federal government, the EU only has direct control over the currency (the Euro). This causes many complications, of these the most well understood has been a competitiveness problem in certain European countries. Countries like Italy and Spain gave up a competitive advantage when they joined the Euro by giving up their cheaper local currencies. A way of offsetting this was to lower the borrowing costs for new members to help eliminate the competitiveness problem without devaluing the Euro currency itself. The problem now is that 10 years after the creation of the Euro, the competitiveness gap still exists.

This is not unique to Europe; in the US we also have a competitiveness gap between US states. Poorer US states like Kentucky, Mississippi, and West Virginia take in much more than they pay into the IRS, while states like California get considerably less back. This translates into long term transfers of wealth from competitive parts of the country to less competitive ones; Europe lacks this redistributive mechanism. At the same time, because the federal government issues bonds on behalf of all 50 states, the fiscal insolvency of one state (say California) is not exposed to the wrath of the markets. In other words, the risk between US states is mutualized by the federal government. Europe currently lacks both of these tools to stymie the crisis.

This brings us back to issue of democracy and the European economic crisis. While some countries have voted in opposition to the austerity drive, German voters have their own reservations on many proposed solutions to the crisis. According to a poll in November 2011, 79% of Germans oppose a European Bond that would combine sovereign debt from Germany with other Euro members. Germans are similarly opposed to any inflation outside of what they view as acceptable. A poll from an insurance company (R+V) asked Germans what their most pressing fear was: last year inflation topped the list with 63% of respondents listing it. These views have been reflected by German policymakers  as Finance Minister Wolfgang Schaeuble denied that Greek bailouts would result in any transfer union in Europe. German opposition to inflationary policy at the ECB has also been pronounced. While some of this stubbornness has changed over time, policymakers still have an obligation to follow the wishes of their citizens or face potential defeat in elections.

Right now the “strategy” to resolve the Eurozone competitiveness problem involves cutting deficits across the EU and relying on “internal devaluation” caused by austerity and falling prices in the most troubled economies (Greece, Ireland, Portugal, Spain, Italy). Unfortunately this process takes a very long time and has put many of the troubled economies into recession. This process is also complicated by German opposition to inflation, as higher inflation in Germany would help make the troubled periphery more competitive.

In the end, the problems affecting the Eurozone will probably require a combination of both austerity measures over time in some countries as well as some form of debt mutualization and fiscal transfers to less competitive countries. This is, of course, just to stymie the medium to long term imbalances facing the Eurozone. In the short term the EU has very dire questions to answer: is the current strategy sustainable, can the Eurozone survive a Greek exit, would it be worth it to tolerate countries rejecting austerity if the alternative was a disorderly departure from the single currency? Above all, can the Euro survive the challenge democracy presents to resolving its many problems?

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The US and EU at a Crossroads: Austerity vs. Expansionism (extra spergy)

01/29/2012 //
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After months of mental stagnation I’ve decided to return to the world of blogging with an extra spergy post on the economic policies being considered on both sides of the Atlantic. Before I expand on this subject I want to send a special thanks to economist bloggers Paul Krugman, Brad DeLong, and Matthew Yglesias for inspiring me. I absolutely don’t belong in the same category as them but I feel so much better informed by their blogs. For anyone looking to learn a little bit more about economics or economic theory I highly recommend following these blogs. For additional perspectives from economists you should also consider the blogs referenced in this compelling economist article.

The topic for this post will be the economic policies that are currently being considered in both the European Union and the United States. Before I go further I want to define two terms that I will be using a lot in this post:

Austerity: “In economics, austerity is a policy of deficit-cutting, lower spending, and a reduction in the amount of benefits and public services provided.[1] Austerity policies are often used by governments to reduce their deficit spending[2] while sometimes coupled with increases in taxes to pay back creditors to reduce debt.[3]” (from wikipedia)

Expansionism: “some have linked the term to promoting economic growth (in contrast to no growth / sustainable policies).” (also from wikipedia)

While some time has passed since the debt ceiling standoff and subsequent downgrade by Standard and Poor rocked US markets, the debate remains central to US economic policy. In recent Republican debates austerity has been almost universally endorsed. Governor Rick Perry went  so far as to propose eliminating three government agencies, though which three is still up for debate. This stance on austerity has also been endorsed by Republicans in Congress, with multiple proposals to reduce government spending in the short and medium term.

Across the Atlantic, similar proposals have not only been proposed but have been implemented in several countries that were affected by the Eurozone debt crisis. Germany’s Angela Merkel has been one of the most ardent proponents in the Eurozone for an austerity-centered response to debt crisis. The economist states:

Italy and Greece, under new technocratic governments, may now be more serious about living within their means and reforming their faults. France, which has run budget deficits since 1974, is adopting austerity. Spain has introduced a constitutional debt brake.”

In both Europe and the United States austerity has been proposed as a solution to the risk of bond market action on sovereign bonds. I think it is critical to understand a few key elements of what this “bond market action” implies here. When governments seek to borrow money, they auction sovereign bonds denominated in the currency used by those respective governments. Governments then have to pay back those bonds with interest. This interest is called the “yield” and has an inverse relationship to demand for those bonds. So if a bond is in high demand, the yield will be low, while a bond with low demand will have a higher yield.

Ratings agencies, which represent the interests of bond-buyers will give ratings on sovereign bonds based on how likely they think they will be repaid. Even though a nation’s sovereign debt rating can be related to its yield, the two don’t always correlate to one another.  When the United States lost its AAA rating from Standard and Poor (the other two major ratings agencies kept the AAA for the US) stock markets lost record volume but demand for US sovereign debt actually went up. As I write this the yield on US 10-year bonds stands at 1.89%, while it stood at 3.01% on July 20th, 2011.

While 2% is considered serviceable, higher yields can cripple a country by forcing it stop borrowing altogether. Greek 10-year bonds have yields more than ten times higher than their US or German equivalent:

At present, Greece would have to pay 34% interest on a ten year loan. This has effectively locked Greece out of selling its debt. It would seem natural then, that the countries that are now bailing out Greece would insist that Greece cut government spending sharply and try to raise more taxes to cut its deficit. After all, if Greece were able to finance its spending without having to borrow money, yields wouldn’t matter, at least in the immediate term. Germany, the biggest Eurozone economy, has led the push for austerity in Greece and other Euro countries with dangerously high yields (Italy, Spain, Portugal, Ireland have all faced high yields).

There is a danger to this logic though, that comes with the effects of austerity. In return for the first bailout, Greece agreed to sharply reduce public spending, including cuts in pensions and wages for public sector workers, yet it still fails to meet deficit targets set by the EU. Germany is now proposing that the EU take direct control over Greece’s government spending, something deeply unpopular in Greece (source). The problem that comes from this arrangement is that austerity has not let to growth in Greece’s economy. In fact, since the first bailout in April 2010, Greece has seen its economy contract sharply:

This is as troubling as this looks, it easily could have been predicted. When you lower spending like Greece has done, you are in effect giving public sector workers/pensioners less money to spend, lowering demand. This weakens economic output across all sectors of the economy, as private businesses adjust to lowered demand by laying off workers and producing less. This does more than just damage the livelihoods of Greek citizens, it actually exacerbates the government’s finances. As Greece’s tax base becomes less wealthy, the government must either raise taxes further (which certainly does not stimulate growth) or continue to run a budgetary deficit just to maintain the status quo.

Greece is not alone in its struggle to grow as the effects of austerity bite, other Euro countries that have recently implemented austerity have seen growth slow:

This graph measures annual GDP growth in the Q3 2011, and with the exception of Slovenia, all of the worst performers had to implement some form of austerity in response to high yields/EU intervention.

It is not just the opinion of amateur bloggers (like me) or angry protesters in Greece that austerity alone cannot ensure debt repayment. Standard and Poor recently downgraded 9 Eurozone countries, and in its FAQ explaining the downgrades stated:

… As such, we believe that a reform process based on a pillar of fiscal austerity alone risks becoming self-defeating, as domestic demand falls in line with consumers’ rising concerns about job security and disposable incomes, eroding national tax revenues.”

The German response to the downgrade borders on intransigence:

German chancellor Angela Merkel has called on eurozone governments speedily to implement tough new fiscal rules after Standard & Poor’s downgraded the credit ratings of France and Austria and seven other second-tier sovereigns.”

This is especially swaying because ratings agencies like S&P have no vested interest in placating debtor states, but instead act on behalf of creditors. Fears over German stubbornness over austerity has led to a recent outpouring of criticism from the world’s economic leaders. IMF head Christine Lagarde, US Treasury Secretary Tim Geithner, and Financier George Soros all warned of dangers of austerity at the recent World Economic Forum at Davos. At a separate summit, Nobel prize-winning economist Joseph Stiglitz warned that Germany was pushing Europe towards a suicide pact, saying:

It is like blood-letting, where you took blood out of a patient because the theory was that there were bad humours. and very often, when you took the blood out, the patient got sicker. The response then was more blood-letting until the patient very nearly died. What is happening in Europe is a mutual suicide pact“

It’s worth noting that Stiglitz had similarly critical things to say about US austerity, pointing out that the US has shed 700,000 public sector jobs over four years. While European austerity has been rightly criticized for its futility, it must be pointed out that Eurozone countries have faced something that the US has not, high yields. One of the most baffling aspects of the aspects of the recent push for austerity across the Atlantic is that, while the US has lost its AAA rating by S&P, its yields have stayed historically low. While it makes little sense for Greece to endure agonizing economic contraction from austerity, it makes considerably less sense for the United States to follow that path. While borrowing costs for the US government are historically low, unemployment remains stubbornly high.

It should be both shocking and perplexing that in spite of this Republicans in Congress have held up virtually every piece of expansionary legislation recently proposed. Republicans have been so opposed to promoting growth through legislation that they nearly blocked a tax cut designed to boost growth from being renewed until they came under intense political pressure and relented.

On both sides of the Atlantic there has been a drive for austerity that has hitherto done little to calm the markets OR promote growth. And while countries with high yields have faced inevitable pressure to reduce deficits, the real tragedy stems from the lack of leadership from countries with the room for maneuver to lead and coordinate expansionary policies. The political systems in Germany and the United States have both been alarmingly inflexible and wrong-footed in their respective approaches to promoting economic growth and stemming the threat of double dip recession.

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Eurozone contagion part 2: the line between creditor and debtor-states blurred.

08/16/2011 //
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A crisis that began in the so-called “peripheral” Mediterranean nation of Greece has become a prolonged disaster, that has enveloped countries that are often seen as the “core” of the Eurozone economy. While in my earlier blog I described the bailouts of Greece, Ireland, and Portugal, many things have changed since then.

The Eurozone has bailed out Greece a second time, and the ECB (European Central Bank) has began purchasing sovereign bonds from Italy and Spain in an attempt to lower yields (interest owed by debtor countries) their debt. This has caused yields to drop on those bonds, though dangers still remain for the Eurozone. Leaders in Europe are now expecting the small Island or Cyprus to need a bailout, in part due to their banks exposure to Greek debt and also from a massive explosion that knocked out power in the island. But Cyprus is less important compared with rumors that emerged early last week: that France could lose its AAA rating and that it’s debt could come scrutiny. While all three major ratings agencies have denied a downgrade, shares in many French banks plummeted on the news. While yields on French debt have been stable, France remains one of the most exposed countries to Greek and other Eurozone debt. As this excellent graph from the BBC shows:

With Greece’s economy continuing to contract in part because of its austerity program, one might ask “what would happen if yields rose on French debt due to exposure in its banking sector and public finance to the Eurozone debt crisis?” I created a graph to illustrate this:

As with the previous blog‘s graph, this shows governments that have been bailed out in red, but now has countries that have been indirectly bailed out (Spain and Italy, via the ECB bond-purchasing scheme) are pink, and countries that might possibly require bailouts in orange.

This creates a much more threatening scenario for the Eurozone as a whole:

This graph shows that were Cyprus and France to both require bailouts, one could only expect non-bailed out states to meaningfully contribute, making potential creditors the minority of the Eurozone for the first time. This possible scenario might have colored Angela Merkel’s statements at today’s joint press conference with French counterpart Nicolas Sarkozy. She turned down the proposition that the Eurozone issue unique “Euro” bonds that would combine bonds with other Euro states, and instead suggested a requirement for eurozone members to balance their budgets should be enshrined in each of their constitutions. Skeptics have argued that austerity could cause too much immediate pain and could lead to new recessions in Eurozone or elsewhere. This comes at a time when the ECB has also been maligned for raising interest rates despite slow economic growth in most of the Eurozone (only Germany and smaller members saw growth of over 3% 2010). Perhaps skeptics should respect that Germany has long been the engine of economic growth in the Eurozone; its exports far outweigh any European competition. But while growth in Germany was robust in 2010, that has all changed. In this last fiscal quarter Germany grew by a mere 0.1%, causing global shares to drop on the news. This news partially vindicates Angela Merkel’s reluctance to expand bailouts in the Eurozone.

This raises a question: can the Euro currency survive in this dangerous climate? I think its still unlikely that the monetary union will collapse in the near term, despite the dire crises that have recently plagued it. One reason for my confidence is the threat it would pose to any member were it to go alone: Greece might be withering under austerity right now, but were it to reintroduce the Drachma and ignore all the debt it currently owes it would still face a primary deficit (the money it spends cannot be covered by the taxes it collects) and offsetting this with printed money could lead to hyperinflation. Meanwhile, Germany’s current stagnation would pale in comparison to damage to exports caused by Germany’s currency appreciating by 28% vs. the dollar, were it to abandon the Euro. With Germany and the debtor states alike bound to the single currency, the most likely option appears to be a grudging acceptance of further fiscal integration of the Eurozone by creditor states and the simultaneous agreement to endure austerity in the zone’s debtor states. The real question is whether this will be enough to save the currency.

UPDATE: to make it clear that the Eurozone is not alone causing financial upheaval I should point out that US is also failing to calm the markets by its own inaction. If the Fed  were to take bold steps towards stimulating the US economy as has been demanded, perhaps the Eurozone debt crisis would be more isolated in its disruption.

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Eurozone contagion: the size of the problem

07/08/2011 //
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In a recent turn of events holders of sovereign debt from Italy, Ireland, Portugal and Greece have sold off some of it, which has increased the yield (amount of interest these countries will have to pay) on their debt. Italy now has to pay 5.35% interest on its debt, while Greece, Ireland and Portugal  now must pay 28%, 16.3% and 18.6% respectively. Spain’s debt was not affected by this recent sell-off but has a current yield of 5.65%. This news is particularly alarming because yield rates had began to stabilize before this recent sell-off. More to the point, Italy (and already struggling Spain) are much more important to the economy of the Eurozone than Ireland, Greece, or Portugal.

A look at this graph on google helps to illuminate the size of the problem. I created this pie graph to show the relative size of the Eurozone’s economies also: (red countries have been bailed out already, pink countries have seen their debt yields rise and ratings fall)

😦

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University rankings inadequacy: two rankings give Europeans heartburn and Americans brief respite?

06/23/2011 //
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News about  university rankings has taken an International Relations twist as the EU has angrily criticized two recent rankings and has allocated funding to create a new system. This was in response to a very low ranking of European universities by the UK publication Times Higher Education, and the Shanghai ranking. Having an emerging superpower like China view Europe’s universities so poorly has led to some European education ministers and university presidents to travel to China and express their concerns and promote their universities. Unlike domestic rankings of US universities (we call them colleges : ) have, these international rankings bring the prestige of a nation’s entire higher education system into scrutiny. It makes sense for countries like Germany and France to fret over these results, as both rankings make their  higher education systems appear to be inferior not just to the US model, but to one of the most eurosceptic members of the EU: Britain. The coalition government in Great Britain has been increasingly critical of European (read EU) integration, and the debt crisis has emboldened them continue to use a separate currency and avoid contributing to Eurozone bailouts (the UK is, by far, the largest EU member-state not to use the Euro). Lets see what these two rankings show:

Of the top 100 from the Times Higher Education, here are some results and analysis: (note: I am lazy so the colors don’t match, sorry)

Immediately it is clear that the EUs higher population and GDP (EU-wide, not Eurozone) does not produce as many top 100 universities compared to the US. But this shows only part of the problem.

Half of Europe’s top 100 universities are in the UK, an impressive feat for a country with a smaller economy and population than Germany. The United Kingdom’s GDP and population figures are very closely matched with France who does terribly on this graph. see my link above for complete results.

Finally, when we include Irish, Canadian, and Australian universities lets see how they perform, as the Anglosphere:

Once you include important universities in Canada, Australia and Ireland it appears that the world’s most desired universities are overwhelmingly English-speaking establishments. Perhaps this ranking system favors that unfairly, it is an independent publication, but it is also a British, independent publication. Russia once had a ranking system that appeared reasonable at first glance, until one found Russia’s own Moscow State University ranked higher than Harvard or Cambridge. Lets see how China’s ARWU or Shanghai Ranking rates the same regions.

The Chinese ranking or ARWU has been out since 2003, but it wasn’t until its recent battering of European universities was combined with the THE ranking for 2010 that Europe responded. Here are the same regions being measured by the 2010 ARWU/Shanghai Ranking: (note: I excluded Moscow State University from Europe because Russia’s relationship with the EU is different than Switzerland or Norway’s)

While Europe clearly does better in the ARWU ranking, the US still dominates the top 100.

Separating Britain from the EU has a similarly bad outcome for Europe, though its not as bad for Europe as the THE rankings showed. To break it down more thoroughly: France has 3 universities compared with Britain’s 11, while Germany has 5, and Switzerland somehow ties with France with 3.

Both the ARWU and THE rankings clearly favor English-speaking universities, with both giving them at least 70% of the top 100 in both cases. The ARWU ranking doesn’t rank Irish universities in its top 100, but does rank Canada and Australia’s universities with 4 and 3 respectively. While one might expect China’s East Asian rivalry with Japan to color the ranking’s view of Japanese universities, this isn’t the case: Japan features 5 universities in the top 100, with no Chinese institutions included. Rounding off the list is Russia’s Moscow State University and Israel’s Hebrew University.

The ARWU has also been criticized for favoring sciences much more than humanities, which might explain why many liberal arts colleges perform badly on this list.

Personally, I think ranking an entire university is an incomplete science at best. It’s easy to rank a university’s prestige, but sometimes that prestige doesn’t reflect a particular program’s strength at a university. For instance, Georgetown and Johns Hopkins both have highly esteemed schools of International Relations and Diplomacy but lack the similar prestige of MIT’s hard science programs, so they lose out in a ranking that favors hard sciences. I’d rather not split hairs ad infinitum over ranking systems and instead focus on the IR implications ofthe recent ranking system debacle.

European integration has been viewed by some of its proponents as a means for Europe to remain relevant in an increasingly multi-lateral world. Don’t just take my word for it, academics have written much about it. French and German politicians and academics have been especially eager to use the EU to promote this goal, and as a consequence, have been equally insecure over its prospects. While the Eurozone’s economy is smaller than the US, the entire EU membership has at least matched it recently. This has led outsiders and Europeans alike to eagerly await an example of European leadership. One of these much anticipated examples ended in spectacular failure at the 2009 Copenhagen Summit on Climate Change.

Europeans anticipated this would be a moment where their divergence with the US on climate change could help to underscore Europe’s relevance as an ec0-friendly alternative to US or Chinese dominance; this made the summit’s outcome exceptionally embarrassing. Prior to the opening of the summit itself was a smaller summit within the summit, where Obama negotiated with China as well as Brazil, India, and South Africa. After the summit appeared to be faltering, it was only efforts by China and the US to reconcile their differences with one another that was able to produce a final draft agreement. This was witnessed at the horror of EU enthusiasts, as it confirmed their worst fears of a world dominated by the G-2 (China and America). The fact that Europe’s failure at the summit may have been planned in advance can only add to the frustrations of European leaders. China’s importance at the summit put European aspirations of global leadership in doubt. The Eurozone debt crisis hasn’t helped matters, with Standard & Poor’s recently downgrading Greece’s sovereign debt to one of its lowest ratings.

It might seem like a poor ranking from two subjective lists shouldn’t bother European politicians and university heads as much as it has, but within the context of an increasingly desperate Eurozone debt crisis and a larger global shift towards the BRIC (the IMF predicts China’s GDP in PPP will overtake the US by 2016) it seems reasonable for such insecurities to exist.

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