Turkey in the era of Erdogan

Turkish diplomacy risks looking naive and ineffective

By Gideon Rachman

Turkey, in the era of Recep Tayyip Erdogan, is playing a regional and global rule that has filled its leaders with pride and ambition.

The country’s record of economic and political success has greatly added to its prestige and power. Some around Erdogan have even spoken of a “new Ottomanism”, that would see the country re-emerging as a dominant force in the region.

But the Arab spring and, specifically, the uprising in Syria have risked exposing Turkey’s claim to a unique influence in its region. Turkish diplomacy, which a couple of years ago seemed to be sweeping all before it, now risks looking naive and ineffective.

Yet, even through the flaws in the Erdogan approach to the world are now emerging, the prime minister can justly point to a transformation in the country’s international image in recent years.

In the decades before the Erdogan era, foreign policy was one-dimensional. Following in the tradition of Mustafa Kemal Ataturk, the country was determined to look West. Its self-imposed mission was to join the European Union (EU).

What's So Bad About Deflation?

The key question: cui bono

by Charles Hugh-Smith

One of the most widely accepted truisms of our time is that deflation is bad: bad for debtors, bad for the indebted government, and therefore bad for the economy.

What all this overlooks is how wonderful mild deflation is for those who owe no debt but who own the debt and the income streams that flow from debt. What the "deflation is bad" argument ignores is who controls the financial and political systems, and what set of conditions benefits them.

The entire Survival+ critique is based on one simple but revealing question: cui bono--to whose benefit?

The "deflation is bad" view naively assumes the Federal government wants inflation to lower its own debt burden. But since the machinery of governance is directed not at what's good for the government, but at what's good for the financial Elites that influence policy, then the only meaningful question is: what's best for the financial Elites?

Europe Has Had Enough, But Can It Stand Up To Gazprom?

Everyone plays dirty, any means to an end

by Jen Alic

Gazprom has Europe’s natural gas market in a stranglehold and Europe is attempting to fight back, first with a raid last year on the Russian giant’s offices and then with a probe launched earlier this week against its allegedly illicit efforts to control the EU’s natural gas supplies.

The bottom line is that the same natural gas revolution in the US, which was enabled by hydraulic fracturing (fracking), is now threatening to loosen Gazprom’s noose on the EU, and Gazprom simply won’t have it.  

To head off a potential natural gas revolution in the EU, Gazprom is pulling out all the stops, and EU officials say that the company has been illegally throwing obstacles in the way of European gas diversification.

Poland’s situation is a case in point. Last year, a US Department of Energy report estimated Poland’s shale gas reserves at 171 trillion cubic feet. Gazprom got nervous. In March this year, the Polish Geological Institute suddenly felt compelled to contradict that report, saying reserves were only around 24.8 trillion cubic feet. In June, Exxon announced it would pull out of its shale gas projects in Poland. Investors started getting cold feet and shares began to drop. Chevron and ConocoPhillips are plodding along with their shale gas operations, for now.

A slap in Hollande’s face

The French Are Having Serious Regrets About Electing François Hollande

By Wolf Richter

France is mired in a stagnating economy. The private sector is under pressure, auto manufacturing is heading into a depression.

Unemployment hit a 13-year high of 10.2 percent, leaving over 3 million people out of work.

Youth unemployment of 22.7 percent, bad as it is, belies the catastrophic jobs situation for young people in ghetto-like enclaves, such as the northern suburbs of Paris.

Gasoline and diesel prices are hovering near record highs. So there are a lot of very unhappy campers.

In a BVA poll, 55 percent of the respondents were dissatisfied with President François Hollande’s efforts to tackle the economic crisis. By comparison, only 31 percent were dissatisfied with Nicolas Sarkozy in 2007 at the end of his honeymoon. Devastatingly, for a socialist: 57 percent believed that he didn’t distribute the “efforts” equitably—same as Sarkozy, the president of the rich.

Should Syria burn, Turkey will ultimately burn too

The Push to Ignite a Turkish Civil War Through a Syrian Quagmire

By Mahdi Darius Nazemroaya

Turkey itself is a major target for destabilization, upheaval, and finally balkanization through its participation in the US-led siege against Syria. Ankara has burned its bridges in Syria for the sake of its failing neo-Ottoman regional policy. The Turkish government has actively pursued regime change, spied on Syria for NATO and Israel, violated Syrian sovereignty, supported acts of terrorism and lawlessness, and provided logistical support for the insurgency inside Syria.

Any chances of seeing some form of Turkish regional leadership under neo-Ottomanism have faded. Turkey’s southern borders have been transformed into intelligence and logistical hubs for the CIA and the Mossad in the process, complete with an intelligence “nerve centre” in the Turkish city of Adana. Despite Turkey’s denials, reports about Adana are undeniable and Turkish officers have also been apprehended in covert military operations against the Syrian Arab Republic. The Turkish Labour Party has even demanded that the US General Consul in Adana be deported for “masterminding and leading the activities of Syrian terrorists.” Mehmet Ali Ediboglu and Mevlut Dudu, two Turkish MPs, have also testified that foreign fighters have been renting homes on Turkey’s border with Syria and that Turkish ambulances have been helping smuggle weapons for the insurgents inside Syria.

Japan is not broke

If Japan Is Broke, How Is It Bailing Out Europe?

By Ellen Brown 

Japan's massive government debt conceals massive benefits for the Japanese people, with lessons for the US debt "crisis".
It was recently pointed out that the Japanese government was by far the largest single non-eurozone contributor to the latest euro rescue effort. [1] This, he said, is "the same government that has been going round pretending to be bankrupt (or at least offering no serious rebuttal when benighted American and British commentators portray Japanese public finances as a trainwreck)."

Noting that it was also Japan that rescued the International Monetary Fund (IMF) system virtually single-handedly at the height of the global panic in 2009, Fingleton asked:

How can a nation whose government is supposedly the most overborrowed in the advanced world afford such generosity? ...

The betting is that Japan's true public finances are far stronger than the Western press has been led to believe. What is undeniable is that the Japanese Ministry of Finance is one of the most opaque in the world ...

Fingleton acknowledged that the Japanese government's liabilities are large, but said we also need to look at the asset side of the balance sheet:

[T]he Tokyo Finance Ministry is increasingly borrowing from the Japanese public not to finance out-of-control government spending at home but rather abroad. Besides stepping up to the plate to keep the IMF in business, Tokyo has long been the lender of last resort to both the US and British governments. Meanwhile it borrows 10-year money at an interest rate of just 1.0%, the second lowest rate of any borrower in the world after the government of Switzerland.

It's a good deal for the Japanese government: it can borrow 10-year money at 1% and lend it to the US at 1.6% (the going rate on US 10-year bonds), making a tidy spread.

Japan's debt-to-GDP (gross domestic product) ratio is nearly 230%, the worst of any major country in the world. Yet Japan remains the world's largest creditor country, with net foreign assets of US$3.19 trillion. In 2010, its GDP per capita was more than that of France, Germany, the UK and Italy. [2] And while China's economy is now larger than Japan's because of its burgeoning population (1.3 billion versus 128 million), China's $5,414 GDP per capita is only 12% of Japan's $45,920.

Egypt’s War on Culture Threatens Not Only Art, But Regional Status

Forward to the past

Dancers rehearse for a performance of "Qasem Amin's Women" at a theater in Cairo February 10, 2010

By Alexander Brock 

Last Friday, a historic book market in the Mediterranean coastal city of Alexandria was destroyed by Egyptian security forces, leaving kiosks in shambles and the streets littered with rare and valuable manuscripts. Political figures and activists were swift to denounce this mindless destruction of Egypt’s cultural heritage, demanding that President Mohammed Morsi take action against the governor of Alexandria who ordered the raid. The governor, for his part, deflected the criticism, claiming that the vendors were operating without a permit.

The ransacking in Alexandria represents the latest in a series of attacks on Egypt’s intellectual and cultural life that is being perceived as a “war on culture,” which, as observers have pointed out, raises serious questions about the Muslim Brotherhood’s commitment to certain essential characteristics of a democratic political order, such as freedom of expression, thought and ideas. But, importantly, the consequences of these forays into Egypt’s creative life reach beyond its borders. Restricting freedom of expression in Egypt could potentially kill Cairo’s ambitions to regain its leadership role in the Middle East and its reputation as the cultural powerhouse of the Arab world.

Egyptian cinema, traditionally the most vibrant such industry in the region, has seen some of its brightest stars either sent to prison or subjected to public defamation in recent months. Adel Imam, Egypt’s most famous comedic actor, was convicted of “offending Islam” in some of his past character roles and was sentenced to three months in jail in April of this year. More recently, a conservative Salafist cleric accused a renowned actress on public television of having committed “on-air adultery,” adding that she was “cursed” and would “never enter heaven.” This prompted President Morsi to hold a meeting with a small circle of prominent artists and intellectuals at his presidential palace, during which he stressed the important function that creative artists serve in the new Egypt, adding that he opposes unfounded slander of any kind. For many, however, the damage had been done and a number of movie stars refused to attend the gathering.

The Lonely Man of the Middle East

How much of Putin, Erdogan really has in him ?

by Stanley Weiss

When Turkish Prime Minister Recep Tayyip Erdogan met in July with Russian strongman Vladimir Putin about the civil war in Syria, political biographers had a right to be confused.

After all, one is the leader of a government that has imprisoned more journalists than China and Iran combined; empowered special courts to arrest citizens on suspicion of terrorism without evidence or the right to a hearing; sentenced two students to eight years in prison for holding a sign at a rally demanding “free education”; and has seen more than 20,000 complaints filed against it in the European Court of Human Rights since 2008.

The other is president of Russia.

That the leader of secular, democratic Turkey—a longtime US ally and member of the North Atlantic Treaty Organization—has managed to out-Putin Putin when it comes to steamrolling civil liberties the past ten years is just the beginning of the way politics is changing on the Black Sea. Even while Putin receives a fresh round of global scorn for the two-year prison sentence meted out to three young women of the “Pussy Riot” punk band, Erdogan has successfully executed every trick in the Putin playbook except one. But it is that one failure that may have the most dramatic effect on Turkey’s future and the direction of US foreign policy.

For two neighbors that fought eight wars between them from the eighteenth through the early twentieth century, Russia and Turkey have a lot in common. Both bridge Asia and Europe. Both enjoyed historic runs as world powers. Both have declared their intention to join Europe. And under Putin and Erdogan, both have taken historic steps away from democracy in an attempt to recapture past glory. Call it the four steps toward autocracy in a global age.

Policy for economic decay

There is of course the possibility that Bernankeism will collapse of its own accord 

By Martin Hutchinson

I discussed last week how Federal Reserve chairman Ben Bernanke's easy-money policies could be reversed should Mitt Romney win the presidency and wish to reverse them. It is only fair, therefore, to discuss the other possibility: should Barack Obama be re-elected and (ignoring his fiscal and regulatory policies, which in any case would be modified by congress) allow Bernanke to run free with US monetary policy for another four years.

In modern history, since Bernanke's policies are unprecedented, we have no easy benchmark by which we can measure this outcome. As in many cases however, Adam Smith, writing before economic growth was taken to be universal and inevitable, has an admirable template for our future in a Bernanke-driven United States, in his analysis of the declining fortunes of 18th century Bengal. 

In "Chapter VIII - The Wages of Labor" of his Wealth of Nations, having discussed the flourishing economies of Western Europe, the American colonies and the static but wealthy China, Smith turns his attention to the problem of decay: "But it would be otherwise in a country where the funds destined for the maintenance of labor were sensibly decaying," he begins. 

That is of course precisely the situation in which the United States finds itself after nearly seven years of Bernankeist monetary policy, which followed 11 years of monetary over-expansion under Alan Greenspan. A decade or more of balance of payments deficits in excess of US$500 billion annually, accompanied by interest rates that have depressed the US savings rate far below the capital needs of the economy and four years of $1 trillion plus budget deficits, have hollowed out the US capital base. 

At last, Japan may be about to abandon its disastrous Keynesian consensus

Moving towards a balanced budget 20 years late

By Thomas Pascoe

The world’s third largest economy is in crisis. That, in itself is not news. The world’s largest economy is also in crisis, as is its second, as is…

What is newsworthy is that, having tried and failed with every other option, the Japanese government may be taking a remarkably novel approach. It appears as though they are going to try to spend close to what they receive in taxation. The Keynesian consensus is coming to an end in Japan, although not before it has wrought enormous damage to one of the world’s great economies.

“The government running out of money is not a story made up. It's a real threat," said Japan’s finance minister Jun Azumi on Friday. Opposition parties in Japan are blocking a deficit financing bill which would allow the government to continue to drive its debt levels above 200pc of GDP. If the opposition holds firm, the government has threatened the unthinkable – it will spend less. Tax rises are also on the table, although the doubling of sales tax to 10pc will not come fully into force until 2015.

This is a turnaround for Japan. The nation’s government has already contorted itself in all the ways now common in the West while attempting to postpone this day. This, after all, is a country whose own central bank rebuked itself last month for breaking its own rule and buying more bonds than there is currency in issue.

Democracy the loser in struggle to save the euro

It is not just Germans who should feel nervous

By  Gideon Rachman

The European Central Bank (ECB) has fired its magic bullet. By promising "unlimited" purchases of sovereign bonds, ECB president Mario Draghi may have kept his pledge to do "whatever it takes" to save the euro. But in rescuing the currency, Draghi’s magic bullet has badly wounded something even more important — democracy in Europe.

As a result of the ECB’s actions, voters from Germany to Spain will increasingly find that crucial decisions about national economic policy can no longer be changed at the ballot box. In Germany, in particular, there is a growing realisation that the ECB, an unelected body that prides itself on its independence from government, has just taken a decision that has profound implications for German taxpayers — but one they cannot challenge or change.

Previous European bail-outs had to be approved by the German parliament and were subject to review by the German courts. Indeed, the German supreme court will rule on the constitutionality of the most recent bail-out tomorrow. But the ECB’s decision to accept unlimited bond purchases is immune to such democratic controls. The bank cannot be overruled by the German parliament. And because it is a European Union institution, it cannot be checked by the German courts, only by the European Court of Justice.

America’s Descent into Poverty

Low-wage work is pandemic in US

By Paul Craig Roberts

The United States has collapsed economically, socially, politically, legally, constitutionally, and environmentally. The country that exists today is not even a shell of the country into which I was born. In this article I will deal with America’s economic collapse. In subsequent articles, i will deal with other aspects of American collapse.

Economically, America has descended into poverty. As Peter Edelman says, “Low-wage work is pandemic.” Today in “freedom and democracy” America, “the world’s only superpower,” one fourth of the work force is employed in jobs that pay less than $22,000, the poverty line for a family of four. Some of these lowly-paid persons are young college graduates, burdened by education loans, who share housing with three or four others in the same desperate situation. Other of these persons are single parents only one medical problem or lost job away from homelessness.

Others might be Ph.D.s teaching at universities as adjunct professors for $10,000 per year or less. Education is still touted as the way out of poverty, but increasingly is a path into poverty or into enlistments into the military services.

Edelman, who studies these issues, reports that 20.5 million Americans have incomes less than $9,500 per year, which is half of the poverty definition for a family of three.

There are six million Americans whose only income is food stamps. That means that there are six million Americans who live on the streets or under bridges or in the homes of relatives or friends. Hard-hearted Republicans continue to rail at welfare, but Edelman says, “basically welfare is gone.”

The Economic Consequences of Cheap Money

There is no means of fooling the public all of the time by tampering with the rate of interest

by Ludwig von Mises

I. The Unpopularity of Interest

One of the characteristic features of this age of wars and destruction is the general attack launched by all governments and pressure groups against the rights of creditors. The first act of the Bolshevik Government was to abolish loans and payment of interest altogether. The most popular of the slogans that swept the Nazis into power was Brechung der Zinsknechtschaft, abolition of interest-slavery. The debtor countries are intent upon expropriating the claims of foreign creditors by various devices, the most efficient of which is foreign exchange control. Their economic nationalism aims at brushing away an alleged return to colonialism. They pretend to wage a new war of independence against the foreign exploiters as they venture to call those who provided them with the capital required for the improvement of their economic conditions. As the foremost creditor nation today is the United States, this struggle is virtually directed against the American people. Only the old usages of diplomatic reticence make it advisable for the economic nationalists to name the devil they are fighting not the Yankees, but "Wall Street."

"Wall Street" is no less the target at which the monetary authorities of this country are directing their blows when embarking upon an "easy-money" policy. It is generally assumed that measures designed to lower the rate of interest, below the height at which the unhampered market would fix it, are extremely beneficial to the immense majority at the expense of a small minority of capitalists and hardboiled moneylenders. It is tacitly implied that the creditors are the idle rich while the debtors are the industrious poor. However, this belief is atavistic and utterly misjudges contemporary conditions.

The Gravy Train is Off the Rails

Europe, A Sterile Landscape...

by Clive Hale

A place incapable of supporting life as we know it – a good description of where ECB monetary policy is leading us. Currency debasement is almost certainly where we are headed because of Dr. Aghi’s assertion that the euro is irreversible, not despite it. He bravely assumes that in making such a statement he is creating an aura of consensus and strength. In its current form the euro is a busted flush and is being held together solely by political intransigence and ECB connivance. From the very beginning the rules of engagement were ignored because without political and fiscal centralisation they weren’t going to work anyway.

But did this stop most of the eurozone countries – and the Southern “Methadone” Zone in particular – from getting on board the gravy train and going on one hell of a trip courtesy of German style interest rates. It would have been rude not to! And no worries about the lack of a long term structure to keep this thing on the rails; we can deal with that later. Well later is now and guess what? They all want to stay on the train but can no longer afford the fare; ignoring the fact that they never could in the first place.

One of the many problems the eurozone faces, along with the US, UK, Japan et al, is how to service their massive debt burden. They can’t, but insist on reapplying the band aid to create the illusion of progress. As Einstein put it, “insanity is doing the same thing over and over again and expecting different results.” We now have OMT to ponder upon – Outright Monetary Transactions. My reaction thus far has been “OMG!” Typical of an ill conceived contrivance, the press release on the “technical” features of OMT comprises 17 short sentences; one of which says, “the liquidity created through Outright Monetary Transactions will be fully sterilised,” but doesn’t say how – that would just be too technical!

The Heart of the US Election

The American Dream is getting out of middle class reach

By Raghuram Rajan

A real debate is emerging in America’s presidential election campaign. It is superficially about health care and taxes. More fundamentally, it is about democracy and free enterprise.

Democracy and free enterprise appear to be mutually reinforcing – it is hard to think of any flourishing democracy that is not a market economy. Moreover, while a number of nominally socialist economies have embraced free enterprise (or “socialism with Chinese characteristics,” as the Chinese Communist Party would say), it seems to be only a matter of time before they are forced to become more democratic.

Yet it is not clear a priori why democracy and free enterprise should be mutually supportive. After all, democracy implies regarding individuals as equal and treating them as such, with every adult getting an equal vote, whereas free enterprise empowers individuals based on how much economic value they create and how much property they own.

How Draghi Opened The Door To Hyperinflation

... And Denied The Fed An Exit Strategy

by Martin Sibileau

We finally heard the intentions of Mr. Draghi, President of the European Central Bank (“ECB”). We only need to know the conditions Germany’s Verfassungsgericht will impose on September 12th. We believe they will be relevant.

On Thursday, Draghi told us he intends (1) to purchase sovereign debt in the secondary market, (2) that before he does so, the issuing country must submit to certain conditions within a fiscal adjustment program, (3) that when he finally buys the debt, he will buy any debt (new or outstanding) with a maturity lower than three years, (4) that after buying it, he will sterilize the transaction, (5) that the collateral pledged so far for liquidity lines will not be subject to minimum credit ratings any longer, (6) that the ECB will accept to rank pari-passu with other creditors going forward, and (7) that the Securities Market Programme will be terminated, with the purchased debt held until maturity. According to Mr. Draghi (but not toGermany), buying debt with a tenor lower than three years does not constitute government financing. The number three, it seems, is a magical number.

We will mince no words: Mr. Draghi has opened the door to hyperinflation. There will probably not be hyperinflation because Germany would leave the Euro zone first, but the door is open and we will explain why. To avoid this outcome, assuming that in this context the Eurozone will continue to show fiscal deficits, we will also show that it is critical that the Fed does not raise interest rates. 

There Must Be Some Way Out Of Here

Debunking Some Myths

By Mark J. Grant

First let me state , with a certain calmness, that there is a Transfer Union underway in Europe. This is the subject, you may recall, that Germany has tried to avoid at all costs which is why Eurobonds and other similar schemes have not been implemented. Europe, however, has found a clever way of implementing such a program and keeping it under the radar from the German citizens. I will explain: 

In Greece, Spain, Portugal and Italy the ECB has implemented a program where the sovereign guarantees some bank’s bonds. The bank then pledges them as collateral at the ECB and gets cash. The bank then turns around and lends the money back to the sovereign nationand provides liquidity and economic sustenance. The Transfer Union is completed as Germany guarantees 22% of the ECB and the European Central Bank is nothing more than a conduit to lend money to the various nations. This contrivance is also not sterilized so that the ECB is, in fact, printing money which is another part of this subterfuge that no one in Europe wants you to know anything about. This strategy is what has kept all of these various countries alive while the political entity, the European Union, tries to decide what to do about the future of the troubled nations. In a very real sense the ECB is the only fully operational part of the European construct at present as the European Union does not have the “political will” to carry out its mandate.

    “The tears I have cried over Germany have dried. I have washed my face.”                      -Marlene Dietrich

The costs of sovereign default

Theory and reality

By Ugo Panizza, Eduardo Borensztein

Sovereign debt is different. Private debt contracts can be enforced in court and court rulings enforced by asset seizures. By contrast, public-debt creditors:

·        Lack procedures for enforcing sovereign debt contracts – partly due to the principle of sovereign immunity.

·        Have ill-defined claims on the sovereign's assets as they cannot attach assets located within the sovereign’s borders, and typically have limited success in going after sovereign assets located abroad.

Since contracts cannot be enforced, why do sovereigns repay and why do lenders lend?

The economist's natural answer is that it must be the case that repaying is cheaper than defaulting (Dooley 2000). But what are the costs of default? In a seminal paper that kick-started the sovereign debt literature, Eaton and Gersovitz (1981) focused on reputational costs and showed that, under certain conditions, the threat of permanent exclusion from financial markets is a sufficient condition for repaying. Successive work by Bulow and Rogoff (1989) emphasised the possibility of trade sanctions. Cole and Kehoe (1998) showed that positive lending can be sustained even if creditors cannot punish defaulting countries. In this class of theoretical models incentives to pay come from the fact that a default would reveal negative information about the government to other parties that are engaging in transactions with the defaulting government (for a detailed discussion, see Panizza et al. 2009).

Measuring the costs of default

In a recent paper (Borensztein and Panizza 2009), we look at four possible costs of default: loss of reputation, reductions in trade, costs to the domestic economy, and political costs (Inter-American Development Bank 2006 provides a detailed description of default episodes over the last two hundred years).

General Motors Co sold a record number of Chevrolet Volt sedans in August

But that probably isn't a good thing for the automaker's bottom line

by Paul Lienert, Bernie Woodall and Ben Klayman

Nearly two years after the introduction of the path-breaking plug-in hybrid, GM is still losing as much as $49,000 on each Volt it builds, according to estimates provided to Reuters by industry analysts and manufacturing experts.

Cheap Volt lease offers meant to drive more customers to Chevy showrooms this summer may have pushed that loss even higher. There are some Americans paying just $5,050 to drive around for two years in a vehicle that cost as much as $89,000 to produce.

And while the loss per vehicle will shrink as more are built and sold, GM is still years away from making money on the Volt, which will soon face new competitors from Ford, Honda and others.

GM's basic problem is that "the Volt is over-engineered and over-priced," said Dennis Virag, president of the Michigan-based Automotive Consulting Group.

And in a sign that there may be a wider market problem, Nissan, Honda and Mitsubishi have been struggling to sell their electric and hybrid vehicles, though Toyota's Prius models have been in increasing demand.

GM's quandary is how to increase sales volume so that it can spread its estimated $1.2-billion investment in the Volt over more vehicles while reducing manufacturing and component costs - which will be difficult to bring down until sales increase.

But the Volt's steep $39,995 base price and its complex technology — the car uses expensive lithium-polymer batteries, sophisticated electronics and an electric motor combined with a gasoline engine — have kept many prospective buyers away from Chevy showrooms.

Why early sovereign default could save the euro

By forestalling timely sovereign default, the ECB is digging the euro's grave

By Harald Hau

The crisis in the Eurozone is primarily a debt crisis. Debt overhang, whether public or private (as it originally was in Ireland and Spain), impedes investment and growth (Reinhart and Rogoff 2010). And it diminishes incentives for fiscal rigor if the benefits accrue mainly to creditors, and aggravates the macroeconomic effects of austerity if much of the additional saving that deleveraging requires is transferred to creditors abroad. Low growth and capital flight reinforce the debt problem and create a downward spiral, from which belated budgetary austerity provides no exit.

Any strategy of dealing with the Eurozone crisis therefore must be evaluated in light of its effectiveness in dealing with the debt overhang problem. Two solutions are possible.

·        Inflation reduces the real value of nominal debt, lowering the debt burden both on the sovereign and all other debtors.

An unanticipated inflation increase of three percentage points amounts to a 34% (compounded) debt relief on a ten-year bond; little of the government debt in question is inflation-indexed (less than 8% in Italy and none in Spain). But such relief hits all investors alike, independent of the solvency of their respective debtors.

·        Or sovereign default writedowns of the face value and interest payments or reprofiling of such payments. These can take various forms.

For example, exchanges of short-run debt for long-run debt and adjustments of the interest payments can help restore sustainability to debt dynamics.