Take it or leave it

The Hundred Years’ German War

    Germany’s dominance was won by national character, not arms or handouts.

By Victor Davis Hanson

The rise of a German Europe began in 1914, failed twice, and has now ended in the victory of German power almost a century later. The Europe that Kaiser Wilhelm lost in 1918, and that Adolf Hitler destroyed in 1945, has at last been won by Chancellor Angela Merkel without firing a shot.

Or so it seems from European newspapers, which now refer bitterly to a “Fourth Reich” and arrogant new Nazi “Gauleiters” who dictate terms to their European subordinates. Popular cartoons depict Germans with stiff-arm salutes and swastikas, establishing new rules of behavior for supposedly inferior peoples.

Millions of terrified Italians, Spaniards, Greeks, Portuguese, and other Europeans are pouring their savings into German banks at the rate of $15 billion a month. A thumbs-up or thumbs-down from the euro-rich Merkel now determines whether European countries will limp ahead with new German-backed loans or default and see their standard of living regress to that of a half-century ago.

A worried neighbor, France, as so often in the past, in schizophrenic fashion alternately lashes out at Britain for abandoning it and fawns on Germany to appease it. The worries in 1989 of British prime minister Margaret Thatcher and French president François Mitterrand over German unification — that neither a new European Union nor an old NATO could quite rein in German power — have proved true.

How did the grand dream of a “new Europe” end just 20 years later in a German protectorate — especially given the not-so-subtle aim of the European Union to diffuse German ambitions through a continent-wide superstate?

Not by arms. Britain fights in wars all over the globe, from Libya to Iraq. France has the bomb. But Germany mostly stays within its borders — without a nuke, a single aircraft carrier, or a military base abroad.

Not by handouts. Germany poured almost $2 trillion of its own money into rebuilding an East Germany ruined by Communism — without help from others. To drive through southern Europe is to see new freeways, bridges, rail lines, stadiums, and airports financed by German banks or subsidized by the German government.

Not by population size. Somehow, 120 million Greeks, Italians, Spaniards, and Portuguese are begging some 80 million Germans to bail them out.

And not because of good fortune. Just 65 years ago, Berlin was flattened, Hamburg incinerated, and Munich a shell — in ways even Athens, Madrid, Lisbon, and Rome were not.

In truth, German character — so admired and feared in some 500 years of European literature and history — led to the present Germanization of Europe. These days we recoil at terms like “national character” that seem tainted by the nightmares of the past. But no politically correct exegesis offers better reasons why Detroit, booming in 1945, today looks as if it were bombed, and a bombed-out Berlin of 1945 now is booming.

Germans on average worked harder and smarter than their European neighbors — investing rather than consuming, saving rather than spending, and going to bed when others to the south were going to dinner. Recipients of their largesse bitterly complain that German banks lent them money to permit them to buy German products in a sort of modern-day commercial serfdom. True enough, but that still begs the question why Berlin, and not Rome or Madrid, was able to pull off such lucrative mercantilism.

Where does all this lead? Right now to some great unknowns that terrify most of Europe. Will German industriousness and talent eventually translate into military dominance and cultural chauvinism — as it has in the past? How, exactly, can an unraveling EU, or a NATO now “led from behind” by a disengaged United States, persuade Germany not to translate its overwhelming economic clout into political and military advantage?

Can poor European adolescents really obey their rich German parents? Berlin in essence has now scolded southern Europeans that if they still expect sophisticated medical care, high-tech appurtenances, and plentiful consumer goods — the adornments of a rich American and northern-European lifestyle — then they have to start behaving in the manner of Germans, who produce such things and subsidize them for others. 

In other words, an Athenian may still have his ultra-modern airport and subway, a Spaniard may still get a hip replacement, and a Roman may still enjoy his new Mercedes. But not if they still insist on daily siestas, dinner at 9 p.m., retirement in their early 50s, cheating on taxes, and a de facto 10 a.m. to 4 p.m. workday.

Behind all the EU’s eleventh-hour gobbledygook, Germany’s new European order is clear: If you wish to live like a German, then you must work and save like a German. Take it or leave it.

Biting the bullet

EU and U.S. have it easy compared with Canada in 1995

The Quebec referendum was the culmination of years of political acrimony particularly accentuated by the Meech Lake
 constitutional discord—all set against the back drop of rating downgrades and an enormous debt burden.

By Derek Holt and Karen Cordes Woods

The night of the Quebec referendum on Oct. 30, 1995 portrayed Canada at its worst. The palpable fear in the markets was keyed off deep intertwined concerns about the country’s fiscal, economic and political circumstances. A respected U.S. financial daily slammed Canada as a “banana republic” and the nation’s political leaders dismissed capital markets critics as “armchair observers who wouldn’t know how to run a country.” Such a market-unfriendly backdrop understandably drew the ire of rating agencies and bond markets as the country faced the threat of breakup and dissolution of monetary union. Simply put, Canada then was Europe today.

The U.S. and core eurozone economies face arguably easier conditions within which to pursue necessary fiscal and political reforms today. Those who say Canada faced an easier time at restructuring its finances than either the U.S. or Europe would today are guilty of historical revisionism at best, and shameful affirmation of today’s global fiscal malfeasance at worst.

Canada’s past experience lends support to Germany’s current opposition to non-sterilized bond buying by the European Central Bank and other short-term solutions in favour of accelerated fiscal austerity and reforms. The only long-run viable policy solution for the ultimate survival of the eurozone is through reining in the purse strings.

Unstable politics With the U.S., France and Germany facing elections over 2012-13, many argue that this makes it harder for them to pursue fiscal austerity today. Political instability in Canada during the 1990s, however, occurred as a backdrop to aggressively pursuing fiscal austerity. The Quebec referendum was the culmination of years of political acrimony particularly accentuated by the Meech Lake constitutional discord. Canada also faced tumultuous federal election campaigns throughout its efforts toward fiscal repair, including 1993 and 1997. The Liberals who led the effort toward fiscal repair were rewarded with a third consecutive majority government in 2000.

Great fear existed in Canada in 1995 over how the debts would be split if Quebec pulled out of Confederation, and whether Quebec would abandon Canadian monetary union. The mountain of debt and the controversial push by the federal government toward solving it in part on the backs of the provinces almost broke up Canada. Eventually, federalism won in Canada simultaneous to achieving fiscal repair and it is this twin battle that Europe must fight now, with the same stakes in play.

World growth It’s a fallacy that it was easier for Canada to right its fiscal ship because the world economy was growing much faster during the period in which it brought its debt-to-GDP ratio from the 102% peak in 1996 through to the 80% range by the early 2000s and the 66.5% trough in 2007. For a commodity producer and trading nation like Canada, it is world GDP that matters, and the country’s fiscal progress was achieved despite the Asian financial crisis, Russia’s technical default and eurozone debt-market turmoil. World GDP growth was only in the 2%-3% range from 1990 through 1995, only accelerated to about 4% growth in 1996-97, and then abruptly slowed again to the 2½% to 3½% mark over 1998-99, when the Asian financial crisis hit. The dot-com bubble period lifted world growth to 4.8% in 2000 and then it crashed again in 2001-02 at about the same time that 9/11 hit, yet it was just after this point that much of Canada’s fiscal repair had been achieved.

After collapsing in 2009, world GDP growth was 5.1% in 2010 and we are projecting it to slow to 3.8% this year, 3.7% in 2012 and 4.0% in 2012. That is still not outside of the bounds of world growth experienced by Canada in the 1990s.

U.S. growth A further fallacy is that Canada could achieve fiscal repair only thanks to the backdrop of decent U.S. economic growth. This argument is heard more from foreign sources than from those who recall that most of Canada’s fiscal improvement in the 1990s was achieved through domestic program-expenditure reduction — not through revenue gains. Federal government program spending as a share of GDP dropped from 17.4% in 1992-93 to about 12% by 2000-01. This five full percentage-point reduction in program spending swamped any changes in revenues, which were largely flat at about 18% as a share of GDP.

Any advantage stemming from decent U.S. growth was more than negated by other severe disadvantages facing the country, versus Europe and the U.S. today.

Interest expense Canada achieved virtuous fiscal rectitude within the context of a crushing interest-expense burden that neither the U.S. nor most of Europe presently face. In the 1990s, total federal public debt charges as a share of GDP soared to about 6.6% by 1990-91 and remained over 5% until the 1997-98 fiscal year, in stark contrast to how low interest rates are keeping the U.S. interest-expense burden at rock-bottom levels today. In order to achieve fiscal balance, Canada had to pursue the draconian cuts to program spending noted above, as a high interest burden made achieving fiscal balance vastly more difficult.

Monetary policy U.S. monetary policy is exceptionally easy right now, in stark contrast to Canada in the 1990s. Canada’s floating currency was pummelled in the 1990s and went from $1.12 against the U.S. dollar early in the decade to about the $1.40 range by 1995, before cruising around such depths until a renewed round of depreciation took it to the $1.50 mark by decade’s end. This is too simplistically offered as an explanation of how Canada must have been able to achieve fiscal balance by relying upon currency depreciation through a floating exchange rate. What’s missing here is what monetary policy was doing, partly in response to such currency weakness, which occurred despite the fact that the Bank of Canada pushed rates skyward, with the overnight rate rising by about four full percentage points to about 8% by 1995. This failed attempt at defending the currency — including through outright intervention — is one of the reasons why the BoC has not attempted intervention since. Thus, Canada achieved fiscal repair against the backdrop of tighter monetary policy that didn’t allow the mixed benefits of currency depreciation to flow through, whereas the U.S. and more of the eurozone should be pursuing fiscal austerity against the backdrop of exceptionally easy monetary policy and forgiving bond markets, which makes the task far easier.

Housing bubble Like the house-price collapse in the U.S. today — and its sharply differing regional magnitudes — Canada and specifically its biggest province of Ontario was going through the popping of a housing bubble in the early 1990s. Toronto house prices had peaked by 1989 and didn’t hit a trough until 1995, when they had fallen by almost 30% in value. Toronto house prices on average did not regain their 1989 peaks until 2002. The depressed state of the country’s housing market was also reflected in housing-start volumes that collapsed from the 200,000-280,000 range of the latter half of the 1980s down to the 100,000-160,000 range from the mid-1990s throughout the rest of the decade.

Labour markets In the 1990s, Canada’s unemployment rate was in double digits. Canada’s truer measure of unemployment stood at about one in five after including discouraged workers who simply dropped out of the labour force. U.S. pressures are comparable today, but the European experience is mixed, from peripheral pressures all the way down to Germany’s 7% unemployment rate.

Corporate balance sheets Europe and the U.S. have the enormous advantage of having excellent corporate balance sheets. That wasn’t at all the case for Canada back in the early 1990s, when the country’s corporate debt-to-equity, interest-coverage and profit-margin ratios were severely strained. The fact that Canada achieved fiscal deleveraging simultaneous to both household and corporate deleveraging made its achievements far more impressive.

Negative feedback effects A Keynesian might argue that now is not the time to pursue fiscal austerity because the global economy is weak. Had that been the prevailing wisdom for Canada in the 1990s, and had Canada not taken a big bath against a weak domestic growth backdrop, it would have never been in a position to reap the benefits of the fiscal dividend that emerged in the past decade. Instead, Canada leveraged its general government debt-to-GDP ratio down from a peak of 102% in 1996 steadily lower throughout the rest of the decade and to 66.5% by 2007, before accelerated pre-crisis spending and the crisis response pushed this ratio back upward to about 84% now. While this ratio has trended higher of late, it remains superior to the 100%-plus U.S. ratio today and Canada’s financial asset position results in a net government debt-to-GDP ratio of just under one-third.

Printing presses Before priming the printing presses to fund governments became the convention across Western economies, Canada achieved fiscal progress the old-fashioned way: through austerity that followed an over two-decade-long debt binge and by paying its bills. The country took its very hard knocks to growth and financial markets versus the unwillingness to do so across much of today’s Western world, and the path toward enhanced federalism and fiscal repair was littered with doubters and critics.

It’s important to rectify a false impression that quantitative easing amounts to cheap insurance in a low-inflation world against global sovereign-debt shocks. Contrary to this view, the full consequences to Germany and the ECB to caving in to pressures to monetize debt are that fiscal profligacy never gets cured and long-run inflation results. For one thing, the moral hazard associated with a central bank bailing out politicians could well amplify future fiscal pressures. For another, it is wistful thinking to hope that central banks will know when to turn off the taps at the right time, given their historical track record, particularly the Fed’s over the decades.

It is in this respect that the eurozone must pick its poison: Risk a greater crisis now toward the possibility of expedited fiscal austerity and effective oversight, or cement the long-run failure of the eurozone project at a later date. The ECB should be much firmer in clearly stating it has no policy desire to rescue politicians in the short term.

As a consequence of its earlier sacrifices, Canada is today part of a dying breed of AAA-rated markets. Its status as the eight-largest global bond market at face value somewhat hides the additional fact that fewer yet are AAA rated among the world’s deepest bond markets. Canada offers an important lesson to nations like the United States and large parts of Europe that are delaying fiscal repair and punting the problem down the road toward a more ruinous crisis later.

Top Guns in action

Blackstone may advise on Greek debt swap

By Jonathan Keehner, Rebecca Christie and Aaron Kirchfeld

A steering committee representing global banks and insurers is close to hiring Blackstone Group LP and two law firms to advise it on debt-swap talks with Greece, according to two people familiar with the matter.

A formal engagement with Blackstone, White & Case LLP and Allen & Overy LLP may be completed as early as this week, said one of the people, who declined to be identified because talks are private. The steering committee was formed last month by a private creditor-investor group and is conducting negotiations on the voluntary debt swap with Greek and European authorities.

Creditors are working with the advisers to limit their losses in a debt restructuring after already agreeing to accept a 50% writedown on the face value of their Greek sovereign holdings. The steering committee, which includes representatives from AXA SA, Commerzbank AG, ING Groep NV and National Bank of Greece SA, is seeking to reach an agreement on the details of a swap in early January, one person said.

“It presumably suggests that they are not accepting a fait accompli,” said Tim Dawson, a Geneva-based banking analyst at Helvea. “You wouldn’t hire these guys if you weren’t trying to reduce your losses.”

Debt Swap

The steering committee is co-chaired by Charles Dallara, managing director of the Institute of International Finance industry group, and Jean Lemierre, a senior adviser to the chairman at BNP Paribas SA, according to a Nov. 28 statement from the IIF.

Frank Vogl, an IIF spokesman, declined to comment.

The IIF, representing more than 450 financial firms, agreed in October in Brussels with European leaders to accept the writedown on their Greek holdings to help the country recover. The swap deal, part of a 130 billion-euro (US$170-billion) second bailout agreement for Greece, is supposed to help the nation reduce its debt to 120% of gross domestic product by 2020.

The steering committee aims for “significantly more progress” in talks on a Greek debt swap scheduled for later this week in Paris, the IIF said in a separate e-mailed statement today. The group met with Greek, European and International Monetary Fund officials in Athens on Dec. 12 and Dec. 13, it said.

Greece yesterday made new proposals on the structure of a debt swap agreement with private creditors, while disagreement remains on key issues, a person on the lenders’ negotiating committee said yesterday. Under one proposal, Greece would give 15 US cents in cash and 35 US cents in new bonds for every euro of existing debt that will be swapped, said the person.

Talks are progressing, and the creditors and government authorities are seeking to find non-cash ways to enhance the value of the new Greek debt, another person said. The negotiations will address terms such as the collateral accompanying the new bonds.

In July, Greece said it hired three banks — BNP Paribas SA, Deutsche Bank AG and HSBC Holdings Plc — to oversee its voluntary bond exchange and debt buyback plan. The government also retained Cleary Gottlieb Steen & Hamilton LLP as its international legal adviser and Lazard Ltd. as a financial adviser, according to a statement at the time

Sun burned

German solar firms go from boom to bust

By Sarah Marsh and Christoph Steitz

When Tino Blaesi joined the solar sector gold rush, he thought his career was made. Seven years later, he is looking for a job outside the industry after his company slashed more than a third of its workforce in one day.

Workers in Germany’s once booming solar energy industry face a shakeout of major proportions following declines in the price of solar panels over the past year.

Cuts in subsidies for solar energy, weaker demand for panels and fierce competition from cheaper Asian rivals are eating into what was once the world’s biggest hub for the production of solar cells, taking the shine off an industry that was effectively born in Germany.

A decision by the German government earlier this year to phase out nuclear energy has done little to reignite the sector. The resulting power gap is likely to be filled by coal and gas rather than solar and wind energy.

“I don’t want to work in this sector anymore, I’m sick and tired of it,” said 44-year old Blaesi, who worked for seven years at Vogt Group, a German support services firm that deals with the planning and logistics for solar plants.

Vogt had some 160 employees in its heyday in the mid 2000s, Blaesi said, but has shriveled as the young industry matured. It was forced to carry out a large round of lay-offs earlier this year after price declines and weaker demand dampened growth.

Subsidies, or so-called feed-in tariffs, through which operators of solar panels receive a guaranteed price for the electricity they generate, made Germany the world’s largest solar market and had created 150,000 jobs by 2010.

But over the past two years, Germany has sharply reduced the tariffs, and a recent proposal to limit subsidies for new solar installations may seal the industry’s fate.

Now, German solar companies are either laying off staff or putting them on reduced working hours. The contrast with the broader economy is stark. Overall, German unemployment has steadily declined in recent years as Europe’s biggest economy outperforms its rivals in Europe.

Since the end of last year, roughly 5,000 companies involved in the solar business have shut up shop, shedding about 20,000 jobs, according to German solar industry group BSW.

BIGGEST CASUALTY

Berlin-based Solon , Germany’s first solar energy company to go public, said late on Tuesday it would file for insolvency, becoming Germany’s biggest casualty so far.

SMA Solar , Germany’s top solar group, said last month it would lay off up to 1,000 temporary workers by the end of the year, citing weak demand for its invertors, a vital piece of equipment in solar systems.

“It’s the worst year the industry has seen in its short history,” Andreas Haenel, chief executive of German solar company Phoenix Solar said.

The bloodletting is particularly bitter since most of the industry’s jobs are located in the formerly communist eastern part of the country, a region that has suffered from an exodus of young, educated people for two decades.

The area around Bitterfeld-Wolfen, about an hour’s drive southwest from Berlin, was a major beneficiary of Germany’s solar boom. A location for solar cell production, it became known as “Solar Valley.”

Andreas Kind recalls the stability that existed before German reunification when the region used to be the hub of former East Germany’s polluting chemicals industry.

Since then, he has been forced to jump from job to job. First the power plant where he worked was decommissioned. Then a few years later a building materials factory he joined was torn down and rebuilt in Poland, where wages are lower.

When he signed up with German solar company Q-Cells in 2005, he thought the rocky ride was over. Back then, Q-Cells was the world’s largest maker of solar cells. In mid-November the company said it would lay off 250 employees. It has also warned that it might not be able to repay a convertible bond due in February 2012.

“People are afraid they could lose their jobs. Many have passed a critical age for finding a new job, including me,” 50-year-old Kind said.

“The nuclear exit meant an energy shift for Germany. But where’s the solar piece of the cake?”

THE CURSE OF GLOBALISATION

Legislation introduced a decade ago by a centre-left coalition of Social Democrats and Greens led by then-Chancellor Gerhard Schroeder offered generous incentives and turned Germany into the world’s largest market for solar panels, sparking thousands of start-ups, some of which became global leaders.

But the incentives, because they were focused on energy production rather than panel manufacturing, also benefited cheaper Asian rivals, which elbowed their way into the market and drove down prices.

Companies in China and Taiwan have dislodged their German peers as the world’s biggest suppliers of solar cells.

This has caused a major geographic rift in the industry. The U.S. International Trade Commission earlier this month approved an investigation into charges of unfair Chinese trade practices in the solar energy sector, ratcheting up tensions with Beijing on the green trade front.

The crisis has led to a wave of bankruptcies in the United States, notably of panel maker Solyndra LLC, showing that European solar players are not the only ones suffering from the industry glut.

“Considering the large direct financial support and the indirect help due to exchange rates, it’s hard to see this as a level playing field,” said Carsten Koernig, managing director of BSW, referring to Asian rivals.

Q-Cells had to take massive writedowns this year for cutting production at expensive European plants, while peer SolarWorld shut down production at one of its U.S.-based solar plants to save costs.

Industry analysts say the shakeout in the German solar sector is unlikely to kill it off altogether. But it will force uncompetitive companies out of the market and push those that remain to lower their costs more rapidly.

“There is clear overcapacity across the whole solar value chain, and we believe many companies may go out of business over the next year,” Jefferies Equity Research analyst Gerard Reid said.

In the long run price declines will be healthy for an industry that relies on government subsidies and wants to become cost-competitive with fossil fuels.

In the meantime, though, workers lured into the sector by its promise will leave disillusioned and empty handed, and Germany will lose some know-how, one of its key resources.

Vogt’s Blaesi says some of his colleagues are heading for southern Germany where there are more jobs to be had in the engineering sector, while others are moving to work for more thriving solar firms abroad.

“It’s a shame because that know-how is disappearing now, many people are no longer working in solar energy because there are fewer jobs and others are emigrating,” he said.

Everything depends on the motives of the sovereign

Lessons from Argentina on the Outcomes of a Possible Greek Default

By R. Thies
In the world of sovereign debt settlements, things have come a long way since Peru settled its 1889 default in part by offering creditors two million tons of guano. While making a great fertilizer, investors were understandably a little disappointed with this outcome. Luckily, the era of debt-restructuring via barter is long past and in its wake settlement terms and processes have rapidly evolved. The largest sovereign default in history, Argentina's in January 2002, is very close to being settled just 8 years and 5 short months later. Looking at the recent history of sovereign defaults gives some clues as to the outcome of a possible Greek restructuring/default, were it to happen, but leaves many questions unanswered.

Intuitively, the Argentina default is the most instructive for the current situation as it is both the most recent debt collapse by an industrialized country (last year's Jamaican default didn't attract much fanfare) and the largest in history at $82 billion. For comparison, Greece will need to roll-over roughly €104 billion ($130 billion) between now and 2013, which does not include additional deficit-financing as needed. Regardless, the scope is comparable. Despite the similarities, the ongoing Argentine restructuring process has been unique, though some of the idiosyncrasies of the process do shed some light.

The Argentine Default and Settlement

Argentina defaulted on $82 billion of principal in January 2002 and did not even meet with its private creditors for more than a year after that time. During this time Buenos Aires government made the bold assertion that they would be settling with different bondholders on different terms, depending on the holder. The first offer from Argentina came at the end of 2003 and amounted to a 75% haircut on debt principal and no compensation for interest arrears. This was considered an egregious, unprecedented offer and was summarily rejected. In the years that followed, even the IMF (who was giving the government billions) spoke out about the fact that Argentina could afford to pay a higher percentage and eventually made settling with creditors a precondition to continuing to receive IMF funding. Eventually, a second offer was made in 2005 that was subscribed to by 76% of creditors which had various components including: swaps for US dollar denominated steep-discount bonds, US dollar-denominated bonds issued at par with steep reductions in coupon payments and some peso bonds with a combination of both. In this way, the Argentine case is relatively typical of modern sovereign restructurings in that the settlement is in the form of swaps for deeply discounted instruments.

In the five years that have followed, Argentina has made various efforts at settling with the remaining holdouts, but the one constant throughout the process has been the stark reality that it is the country that holds the power. As long as the default-country is willing to be locked out of international capital markets, the bondholders hold few cards and may only end up holding guano. The Argentina holdouts will likely settle some time this month and will receive no better terms than they were offered five years ago. While Argentina has held the cards during this process, its economy has certainly suffered as a result of the prolonged nature of the lockout. The other debt restructurings from the late 1990s- early 2000s were all settled within months, even Russia settled up within three months of its 1998 default (albeit at a steep discount). In this regard, Argentina was a special case.

What lessons can be drawn about sovereign restructuring?

Everything depends on the motives of the sovereign. Argentina low-balled investors because it could and was not terribly afraid of the consequences. Further, domestic political pressures encouraged stiffing foreign investors. In the Greek case, foreign could imply everyone outside of Greece, everyone outside of Europe, or theoretically, everyone outside of Germany.

Incomplete legal authority governs sovereign debt restructuring. Laws vary widely by the country in which the debt is held. For example, in the UK a majority of bondholders can agree to a settlement that the minority opposes - not so in the US or the rest of Europe.

If a sovereign wants to discriminate amongst holders, it can.  This comes at a cost to the future perceived creditworthiness of the country, but in the right situation, this is an option. One can easily imagine various situations where a restructuring country protects domestic investors or the banking system of continental Europe, for example.

The IMF will continue to lend to a country after it has defaulted as long as it is making a 'credible' effort to adhere to austerity. This is particularly important because IMF programs, aimed at long-term solvency, may even mandate a maximum percent of GDP that can be devoted to interest payments. In this way, the IMF has been viewed as a sponsor of a default, usually at the expense of private creditors.

Recovery rates vary widely. The average weighted sovereign recovery rate for the period 1985-2002 was 41%, according to Moody's. Recovery rates are further affected by the cohesiveness of the bondholders. S&P estimated the recovery rate in the event of Greek restructuring to "average" 30-50%.

What does this mean for Greece?

If a restructuring were necessary, the dynamics would be much different than they were in Argentina and other recent defaults. Namely, there is broad cohesion amongst holders of the debt, specifically in this case, French and German banks. Bargaining power of this nature would be expected to improve the terms creditors receive. Further, the ability of sovereigns to discriminate and settle with different holders on differing terms would seem to support the possibility of a Greek restructuring. In light of European central banks continuing significant purchases of Greek (and other euro-zone peripheral country) debt, a situation could be envisaged where private holders are largely protected in a restructuring and central banks receive the discounted swaps.

A key issue to monitor is the status of IMF lending to Greece. Early rumors were that the IMF would forfeit its preferred creditor status in this instance and subsequent comments from the Fund seem to confirm that is a possibility. If this multilateral debt is subordinate, it is a good indication that, at least in the eyes of the IMF, the package will be sufficient to stave off default/restructuring.

The most important thing to keep in mind when considering the possibility of a Greek restructuring is that every episode of sovereign default has looked different and with the advent of the EU's massive $950 billion package announced over the weekend, this is true now more than ever. Further, as a member of a currency union, Greece cannot pair a restructuring with a large currency devaluation, two things that have usually gone hand in hand. That factor alone is enough to conclude that a Greek default would be hugely different than anything we've witnessed. A final point to keep in mind, as the Argentina case demonstrated, as much as it may look like the IMF or other countries (Germany) are pulling all the strings, the decision at the end of the day is in the hands of the country's government. If the outlook for fiscal austerity is even more unpalatable than the consequences of a default/restructuring, then it's just a matter of time.

Extend and pretend

Debt crisis lessons from Latin America

By John Paul Rathbone

It is only vanity that makes anyone believe they are special or “different”. Asia didn’t think Latin America’s long history of financial crises held many useful lessons in 1997; it did. The same is true of Europe. It risks falling victim to the same vanity today.

Take UK Prime Minister David Cameron’s much touted “big bazooka”. In 1980s Latin America, such comprehensive packages were simply known as “el paquete”. Of course, “el paquete” is only the beginning of the end of a crisis. The real challenge is implementation. This requires leadership.

Technocratic governments (like in Italy and Greece) can work. Fernando Henrique Cardoso, for example, was an academic before he became Brazil’s finance minister and twice president. But bear in mind that Mr Cardoso had a popular mandate. Without that, any government is just a caretaker.

Argentina is a case in point. In 2001, it ran through a series of governments before triggering the world’s then-biggest default ($100bn; so small compared to Italy’s €1.9tn bond market). Even the brilliant economist Domingo Cavallo failed to turn the tide. To restore competitiveness without breaking Argentina’s euro-like currency peg, he engineered a “synthetic devaluation”. Across-the-board export subsidies and import duties came straight out of the textbooks, but didn’t work. Just as they often do in Europe today, investors saw the country’s debt dynamics still working against it.

Default fears led to higher bond yields, which led to lower growth and smaller government revenues. This made default more likely in a process that soon became self-fulfilling. After three years of recession, much of southern Europe may already be at this point.

Even loan support from a multilateral – be that the International Monetary Fund or the European Central Bank – can make matters worse. Why? Because one condition of their help is seniority in a sovereign’s debt structure. This converts private investors into “junior bond holders”. Large official interventions can thus produce the opposite of what they mean to do: an investor rush for the exit.

The next stage is all too familiar. Citizens also withdraw their savings before they are converted into devalued pesos, drachmas or liras. A bank run ensues. To prevent a collapse of the payments system, the government announces a devaluation – often over a long weekend. The next day, all hell breaks loose.

These scenes are not out of the question in Europe, and to prevent them, a workable plan is required. Another pre-condition for success: it cannot be seen to be imposed from abroad. Without national support, failed adjustment plan follows failed adjustment plan.

Fresh money to support each new package is loaned under the rubric: “extend and pretend”. Finally, a plan gains traction. But in the intervening period, strange political fauna can emerge. This was particularly true in Latin America, where democracy was then only ankle deep. Yet is it odd that the new Italian defense minister is a military man rather than a civilian? Spanish democracy is less than seven years older than Brazil’s, and unified Italy is two-thirds the age of most Latin republics.

Finally, of course, bear in mind that the adjustment is very painful. Latin America’s “lost decade” meant years of falling real wages and rising unemployment. As social unrest grows, old scapegoats are often resurrected. In Latin America, with its colonial history, the backlash was against the “Washington Consensus”. In Europe, where Germany is the banker, it may be 20th-century history. But rising anger is hardly surprising. When has a debtor ever said anything nice about its creditor?

Europe, of course, is not Latin America. If anything it is in a worse situation. It is more indebted and probably less able to stomach tough adjustment programs. “They don’t know how to suffer,” Ernesto Zedillo, the former Mexican president, has said of southern Europe.

European banks are also part of the crisis, which is as much a problem of over-lending as over-borrowing. At least in Latin America, the banks were mostly abroad. Europe should have one factor in its favor. With stronger institutions, it could reach the right solution faster. But higher economic costs always follow poor and tardy policy making.

Exposed

The snobbery and intolerance of the EU elite

The chattering classes’ hysterical reaction to David Cameron’s veto of a revised Lisbon Treaty reveals the dark heart of pro-EU sentiment.

By Frank Furedi

As I drive along listening to the BBC Radio 4 show, The World At One, I am left in no doubt as to this programme’s deep hostility to prime minister David Cameron’s decision to veto changes to the EU Lisbon Treaty.

When the presenter, the usually sensible Martha Kearney, asks Andrus Ansip, the prime minister of Estonia, if he thinks there is increasing anger in the EU over Cameron’s actions, I realise that something very weird is going on. Why ask the leader of a small Baltic state how he feels about the prime minister of Britain? Since when have the emotions of foreign political leaders been a serious topic of concern for a programme titled The World At One?

Kearney does not simply pose the question to Ansip; she prefaces it with comments about how other EU leaders are very angry at Cameron. Nevertheless, her attempt to incite her interviewee to reinforce the BBC consensus on the state of European emotionalism doesn’t quite succeed. ‘I am not angry’, replies Ansip. Possibly he is too ‘old Europe’ and too old school to be conversant in the values of today’s communications clerisy, which cleaves to the doctrine of emotional correctness. Ansip disagrees with Cameron but he does not suffer from the emotional incontinence demanded of him by the BBC.

At first sight, it is difficult to understand the intense level of anger and outrage directed at Cameron by opinion formers and cultural entrepreneurs. Since when have the EU and the Lisbon Treaty acquired such a sacred status among the clerisy? The EU is many things, but it has never been a much-loved institution. So why is it that, all of a sudden, scepticism towards this institution is treated as the moral equivalent of Chamberlain’s act of treachery in Munich in 1938?

It is one thing to accuse Cameron of committing a diplomatic faux pas or the Foreign Office of ineptitude. But the criticisms currently being made of Cameron verge on the hysterical. When I listen to the hyperbole about what will apparently be the consequences of his destructive behaviour, it almost sounds as if he has committed an act of political betrayal in order to appease a handful of incorrigible reactionary Eurosceptics.

Why this over-the-top reaction to what could turn out to be a relatively minor case of diplomatic miscommunication?

Outwardly, the anger of the cosmopolitan clerisy is directed at Cameron’s alleged appeasement of Tory Eurosceptics. The term Eurosceptic has a special meaning for the adherents to cosmopolitan policymaking. In their view, Euroscepticism is associated with values they abhor: upholding national sovereignty, Britishness and a traditional way of life. The moralistic devaluation of these values was vividly communicated by the New York Times columnist Roger Cohen, who this week characterised Tory Eurosceptics as the ‘pinstriped effluence of an ex-imperial nation’. He seeks to dehumanise these people by arguing that this ‘specimen’s ascendancy’ was reflected in Cameron’s behaviour during the treaty negotiations. Cohen’s moral devaluation of Eurosceptics, his dismissal of them from the ranks of humanity, is captured in his description of them as a ‘bunch of insular snobs who seem to have a hard time restraining their inner fascist’.

The intemperate language suggests that the venomous anger directed at Eurosceptics cannot simply be driven by the clerisy’s love affair with the European ideal. Rather, what is at issue here is the clerisy’s preference for the technocracy-dominated and cosmopolitan-influenced institutions of Brussels. From their standpoint, the main virtue of the EU is that its leaders and administrators speak the same language as the UK clerisy. They read from the same emotional and cultural script, which they believe to be superior to the script and values associated with national sovereignty. That is why it isn’t surprising that a BBC journalist can casually ask the Estonian prime minister to have a go at her own national leader. The UK-based communications clerisy has a greater affinity with the outlook of EU technocrats and political administrators than it does with the outlook of its own people.

Of course, Cameron may be isolated in the corridors of power in Brussels - but the clerisy is more than a little out of touch with popular sentiments in Britain. Indeed, their visceral castigation of Eurosceptics is actually a roundabout way of morally condemning what the old oligarchy used to call ‘the little people’. The main sin of Euroscepticism is that it has the potential for mobilising popular sentiment. And certainly, the anger of the cosmopolitan elite does not resonate with people getting on with their lives in Birmingham, Newcastle or Leeds. Those who want to expose the heinous Eurosceptic plot to undermine the EU should remember that opinion polls demonstrate that the majority of the UK electorate does not like the EU, and when the Mail on Sunday carried out a poll asking ‘was Cameron right to use the veto?’, 62 per cent of respondents said ‘yes’.

In Britain, even at the best of times the EU has rarely been conceptualised as anything more than a pragmatic convenience. Historically, significant sections of both the left and the right have been critical of the bureaucratic ethos of this institution. Even those of us who love Europe, its history and its culture, and who strongly value the coming together of European peoples, have never had much affection for the institutions of the EU.

One final point: the cosmopolitan values of the clerisy have no progressive content. They contain no real universalist aspirations but rather reflect the sectional outlook of a cultural oligarchy which revels in drawing distinctions between itself and the great unwashed. The clerisy’s alternative to national sovereignty is not some other form of democratic decision-making; on the contrary, it is the fervent advocacy of insulated decision-making. The pro-EU elite continually tries to establish institutions that insulate decision-makers from citizens, and it prefers the rule of technocrats and experts over elected representatives.

Scepticism towards the EU is a legitimate, democratically informed standpoint. Scepticism towards Europe is not, of course. Some of my German friends are more than a little astonished to have discovered that a small number of English towns have decided to cancel twinning arrangements with local authorities on the continent. Yes, some of these arrangements were administratively orchestrated and did not genuinely bring together the peoples of Europe. But on balance, we need to be reaching out to our fellow citizens across the continent, to show that Europe is not an artificially constructed institution but is its people!

Poverty Cure

From Aid to Enterprise

There is no such thing as a Free Market without Free Banking

Larry White Explains Free Banking

Production for people, not profit!

The Social Function of Profit-and-Loss Accounting

by Robert P. Murphy

Many naïve observers of the market economy dismiss concern with the "bottom line" as a purely arbitrary social convention. To these critics, it seems senseless that a factory producing, say, medicine or shoes for toddlers stops at the point when the owner decides that profit has been maximized. It would certainly be physically possible to produce more bottles of aspirin or more shoes in size 3T, yet the boss doesn't allow it, because to do so would "lose money." On the other hand, many apparently superfluous gadgets and unnecessary luxury items are produced every day in a market economy, because they are profitable. Observers who are outraged by this system may adopt the slogan: "Production for people, not profit!"

Such critics do not appreciate the indispensable service that the profit-and-loss test provides to members of a market economy. Whatever the social system in place, the regrettable fact is that the material world is one of scarcity — there are not enough resources to produce all the goods and services that people desire. Because of scarcity, every economic decision involves trade-offs. When scarce resources are devoted to producing more bottles of aspirin, for example, there are necessarily fewer resources available to produce everything else. It's not enough to ask, "Would the world be a better place if there were more medicine?" The relevant question is, "Would the world be a better place if there were more medicine and less of the other goods and services that would have to be sacrificed to produce more medicine?"

In standard introductory textbooks, they often define the economic problem as society's decision on how to allocate scarce resources into the production of particular goods and services. In reality, "society" doesn't decide anything; individual members of society make decisions that interact to determine the ultimate fate of all the resources at humanity's disposal. In the pure market economy, everyone in society obeys the rules of private property, which assign ownership claims to particular units of resources.

In this context, market prices are formed when individuals engage in voluntary exchanges with each other. The resulting prices in turn give entrepreneurs the ability to calculate (expected) profits and losses from various possible activities. It is the interaction of property owners in voluntary trades that "determines" what goods and services get produced, but the signals provided by market prices — and the resulting calculations of profit and loss — help the property owners make informed decisions.

It might be useful to step back and look at the big picture. The entrepreneurs offer money to the owners of labor services, capital goods, and natural resources. The entrepreneurs then use these inputs to produce goods and services which they sell to consumers for money (see figure below).

When a particular entrepreneurial venture goes "out of business," what that ultimately means is that consumers were not willing to spend enough money on its finished output to cover the offers the entrepreneur needed to make in order to bid the scarce inputs away from otherentrepreneurs who wanted the inputs for their enterprises.

To see this principle more concretely, let's work with a silly example. Suppose a successful builder dies and passes on his business to his foolish son. The son gets the bright idea to build new apartment buildings covered with pure gold. He correctly estimates that there would be high demand for apartments where the elevator, hallways, and kitchen shelves were coated with gold. In fact, the son can rent his units for much higher monthly fees than the owners of normal apartments in similar locations.

Of course, this isn't the whole story. Even though his revenues are very high, the foolish son's production costs are astronomical. In addition to the labor, wood, concrete, and other items, he must spend hundreds of millions of dollars buying large quantities of gold. His accountants inform him that despite the higher revenues, he is losing incredible amounts of money because of his decision to coat the apartments with gold. The son will have to either wisen up quickly, or he will squander all of his wealth. Either way, he won't be building apartments coated with gold for very long.

Now if we were to interview the son and ask him what happened, he might say, "It's too expensive to use gold in my business." But notice that this can't be true for all entrepreneurs. After all, the reason gold is so expensive is that other buyers are paying such high prices for it. For example, jewelers still find it profitable to buy gold in order to make necklaces and earrings, and dentists still find it profitable to use gold for fillings. No jeweler would say, "It's too expensive to use gold in my business."

Loosely speaking, the profit-and-loss system communicates the desires of consumers to the resource owners and entrepreneurs when they are deciding how many resources to send into each potential line of production. It's ultimately not the owners of gold mines nor the captains of industry who determine how gold will be used in a market economy. Instead, these decisions are largely guided by the spending decisions of the consumers. It is the consumers' demands for normal versus gold-coated apartments, in conjunction with their demands for silver- versus gold-coated necklaces, that leads to the outcome that gold-coated apartments are ridiculously unprofitable while gold-coated necklaces are perfectly sensible.

The profit-and-loss test provides structure to the free-enterprise system. People are free to start new businesses and to sell their resources (including the labor services of their bodies) to whomever they wish. In a market based on the institution of private property, profits occur when an entrepreneur takes resources of a certain market value and transforms them into finished goods (or services) of a higher market value. This is the important sense in which profitable entrepreneurs are providing a definite service to others in the economy. Without the feedback of profit-and-loss calculations, entrepreneurs would have no idea if they were making economical use of the resources used up by their business operations.