Policy Makers Claim That Europe Is Finally Stable, Long Emergency Is Over – Not So

By Paolo von Schirach

September 27, 2013

WASHINGTON – It is a sign of the times that listless Europe, run by unimaginative politicians fearful of social reactions to anything that might even resemble serious pro-growth reforms, is deemed to be finally on the mend. Things are looking up, we are told by policy-makers. The long and grueling fiscal crisis emergency is over. We are back to normal. So much so that incumbent German Chancellor Angela Merkel did extremely well in the recent elections. Her steady hand and her pro-austerity (but still cautious) policies were apparently vindicated, and so she won the day.

Dismal numbers

Well, it may be so in Germany. But if you look at Europe, the picture is still very grim, unless you really believe that a Eurozone economy now 3% smaller than its pre 2008 crisis levels is a good sign of recovered health. And if you look closely at the sorry Club Med bunch, (Greece, Italy, Cyprus, Portugal and Spain), things are far worse. All of their economies are still way below pre crisis levels, (Greece is down 28%, Italy 8.8%). And no Southern European country is  about to begin a strong recovery. And what about a 12% Eurozone unemployment levels, (with peaks above 25% in Spain and Greece)? Is this yet another sign of health?

North South divide

Sure enough, Northern Europe, with Germany, Austria and the Scandinavian countries in the lead, is doing reasonably well. But France, the Eurozone number two economy, is not; and Eastern Europe is a mixed bag at best. Still, if the totally unjustified consensus is that this European Union has recovered and that it is now ready to resume business as usual, this means that there is no interest in facing reality and in re-examining the very foundations of a Union among far too disparate members that demonstrably are unable (because of resource levels, profoundly different cultures and psychologies), to function according to the same rules. 

While they all share the geography of this Western appendix to the Asian Continent, the Europeans are traveling at different speeds. Some –Greece being the most obvious example– are in such bad shape that they are clearly incapable of advancing without (permanent?) help from rich Northern partners. 

And, even more fundamentally, the financial crisis revealed profound cultural differences between North and South in Europe. The North believes in growth and responsible government. The South believes in debt, while tolerating graft and corruption as rather normal ways to conduct business.

Governance, Italian style 

Way before the crisis, Silvio Berlusconi long premiership showed the world that the Italian voters could not care less about glaring conflicts of interest (Berlusconi retained de facto control over a vast media empire as he served as Prime Minister) and self-serving legislation. Not to mention that he was the Prime Minister who hosted many “bunga-bunga parties” featuring sexy young women, saucy events described by Berlusconi’s friends as “elegant dinners“. Even now, with Berlusconi finally convicted of tax fraud at the end of one of so many trials, it is not clear that he will be expelled from the Senate, as the law would mandate. In fact, should he be expelled, his party may cause the collapse of an ultra fragile government coalition as a protest against what it believes to be a political punishment. And this is happening in Italy, the Eurozone third largest economy, and one of the original founders back in 1957 of the European Common Market, not in Sudan or Mali.

A slimmed down EU, with only the more modern countries in it, can do rather well. But this patchwork Europe, with the rich having to carry the negligent and indolent poor for the indefinite future, is doomed to eventual irrelevance.

 

 




S&P Downgraded France, Half The Eurozone, Citing Inadequate EU Policies – In Italy Lack Of A Long Term Growth Strategy, While Corruption And Bad Governance Linger

[the-subtitle ]

By Paolo von Schirach

January 13, 2012

WASHINGTON – Only yesterday the international business media sounded very optimistic about the Eurozone. They reported that Mario Draghi, president of the European Central Bank now thinks that the situation has been stabilized. Auctions for short and medium term Italian and Spanish bonds had gone well. Yields are down. So, is Europe finally out of the woods? Well, not so fast. Today, Standard & Poor’s downgraded half the Eurozone, including (supposedly) recovering Spain and Italy. And France lost its coveted AAA rating.

S&P pesssimistic outlook

Beyond the action that was expected and therefore largely priced in by the markets, it is important to read the motivation provided by this key credit rating agency, because it presents a totally unflattering and pessimistic picture of Europe’s ability to eventually get out of this mess. In other words, this S&P credit downgrading most likely is not going to be the last, unless policy makers change course. And S&P does not believe that they will. Here is an excerpt from a much longer S&P statement:

“….Today’s rating actions are primarily driven by our assessment that the policy initiatives that have been taken by European policymakers in recent weeks may be insufficient to fully address ongoing systemic stresses in the eurozone. In our view, these stresses include: (1) tightening credit conditions, (2) an increase in risk premiums for a widening group of eurozone issuers, (3) a simultaneous attempt to delever by governments and households, (4) weakening economic growth prospects, and (5) an open and prolonged dispute among European policymakers over the proper approach to address challenges.

The outcomes from the EU summit on December 9, 2011, and subsequent statements from policymakers, lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the eurozone’s financial problems. In our opinion, the political agreement does not supply sufficient additional resources or operational flexibility to bolster European rescue operations, or extend enough support for those eurozone sovereigns subjected to heightened market pressures.

We also believe that the agreement is predicated on only a partial recognition of the source of the crisis: that the current financial turmoil stems primarily from fiscal profligacy at the periphery of the eurozone. In our view, however, the financial problems facing the eurozone are as much a consequence of rising external imbalances and divergences in competitiveness between the eurozone’s core and the so-called “periphery”. 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…..”

S&P identified systemic flaws, more downgrades to come?

So, according to S&P, despite the great optimism after the latest EU summit, policy measures taken so far are insufficient. Worse yet, there is a failure to recognize that the crisis is largely due to lack of competitiveness resulting in economic weakness. There is lack of understanding that austerity alone, without credible growth policies, makes matters worse because it sucks even more resources from anemic economies.

Beyond the polite formal language, S&P downgraded many Eurozone countries because the EU policies aimed at solving this more than two year long crisis do not add up. Which is to say that the plethora of EU summits and solemn declarations and unity pledges are inadequate and not credible. Amazingly enough, after all this time, the EU has yet to attack the problem in a convincing way. (Translated in simple language: they do not not how, or they are too afraid to take bold steps). Hence this raft of downgrades.

Italy’s outlook is not good

But let’s look at some specifics. Let’s look at Italy as a good illustration of a half baked plan. In the Fall, when the situation was dire, the ethically challenged perennial Prime Minister Silvio Berlusconi was forced out of office, for the good of Italy. In his place comes a dignified non politician: Mario Monti, President of the prestigious Bocconi University in Milan, former EU Commissioner and internationally respected economist. This change at the top alone was supposed to inspire markets as they would finally see a serious person in charge. To his credit, Monti and his technocratic government of non political experts, went to work on some more austerity measures aimed at showing lenders that Italy is serious about cutting spending.

A growth strategy?

But after Monti did that, all observers started asking about his plan to kick start growth in a stagnating Italian economy. Well, there is no real plan. Sure enough, there are some initiatives at liberalizing access to professions and economic activities. But even timid talk about introducing real labor mobility was met with ferocious labor unions’s reactions. No, sir. Our coveted right to life time employment is not for discussion. And liberalization efforts are met with equal resistance from all those who stand to lose equally coveted rent positions based on restricted access.

Corruption lingers

Worse yet, the old and time tested Italian bad habits are still there. As soon as Monti came into office, a major political scandal linking parties, partially state owned corporations Finmeccanica and public contracts exploded. Most recently, Carlo Malinconico, his very own undersecretary to the Prime Minister, (the equivalent of a Cabinet Secretary) , had to resign because of a cloud of suspicion regarding shady past dealing with questionable economic entities. And the Italian Chamber of Deputies just refused to lift the immunity protecting one of its members, Nicola Cosentino, from prosecution for alleged connections with the Casalese clan, part of Camorra, Naples’ most powerful criminal organization.

With all this, no wonder that Italy has very poor ratings on corruption from Transparency International, while it scores badly within the World Bank’s ”Doing Business” tabulations that rank all countries on the easiness to conduct routine economic operations and on the efficiency of public services that should support business activities.

The spread between German and Italian bonds

And, Mario Monti wonders why Italy is forced to pay more than 6.5% interest on its 10 year bonds, while Germany pays less than 2%? The answer is simple. Because Italy has bad governance and low ethical standards. The country is systemically weak and there is no sign that this will improve. Simply put, in the short term the government can raise taxes an d reduce the deficit, as it did. But if this is all the ammunition they’ve got, the battle is lost.

Just a few notches ahead of a Banana Republic

With all due respect for Monti’s personal integrity and skills, he is governing a country just a few notches ahead of a Banana Republic. In order to have meaningful growth, (and that means at least double the miserable 1% that Italy had in the last few years), in this super competitive, globalized world you need good governance, excellent public services, modern policies, first class entrepreneurs and flexible, adaptable labor markets. I see none of that in Italy and, Monti’s reform efforts notwithstanding, a slim chance of making any of this happen. Hence the S&P downgrades and the almost 5% spread between Italian and German 10 year bonds.




European Financial Rescue Measures May Not Work As Intended – Italy Facing Higher Borrowing Costs – Besides, Rescue Addresses Only Symptoms – Europe’s Real Problem Is Low Growth

[the-subtitle ]

By Paolo von Schirach

October 29, 2011

Related stories

http://schirachreport.com/index.php/2011/10/25/will-european-debtfinancial-crisis-be-solved-yes-but-not-soon-eu-institutions-weak-hesitant-national-political-leaders-will-not-move-fast-enough/

http://schirachreport.com/index.php/2011/10/27/europeans-agreed-on-measures-to-end-debt-crisis-greek-debt-will-be-reduced-rescue-fund-to-be-augmented-eu-banks-to-increase-reserves-yet-serious-doubts-about-implementation-italys-ability-to/

WASHINGTON – In recent articles (see above) I pointed out that Europe, while moving forward in this never ending debt/financial crisis mess, cannot be trusted to take truly definitive steps. And most recent developments fit the pattern. Last Thursday there seemed to be a major breakthrough: Nicolas Sarkozy, Angela Merkel and all the others announced a ”final plan” to reduce Greek debt, and critical decisions to recapitalize compromised banks and to beef up the eurozone rescue fund currently managed by the European Financial Stability Mechanism.

Questions about missing details

The problem is that key details are missing. Clarifications regarding modalities and timing of implementation will come later. And this vagueness invites suspicion that this is not a firm EU commitment, but just half baked plan that may or may not work. “Doubt Rise on EU Deal“, reads the October 29-30 The Wall Street Journal front page headline.

Higher interest rates for new Italian bonds

The first test came just one day after the big announcement. Italy wanted to place new bonds, and the markets immediately asked for a higher interest rate. And this is the evidence of a EU plan that fails to convince key players. Unmistakable clarity that henceforth the EU will guarantee all sovereign debt would have reassured investors. They would have asked for the same or lower interests on new Italian debt. Well, the opposite happened. The immediate reaction to measures ostensibly conveying the message that risks have been reduced is that investors demand higher interest rates. This means that the markets, so far at least, do not buy the plan, while the also do not buy the seriousness of Prime Minister Silvio Berlusconi’s stated pledges to fix Italy’s finances.

Symptomatic remedies will not do

More broadly, the markets may begin to sense the limitations of all these extraordinary measures. Even if they really worked as intended, these remedies are symptomatic, as they fail to address the root causes of Europe’s ills. In essence, Europe has weak finances because it has bloated public sectors and weak economies that cannot support them. Whereas the Europeans are desperately trying to shore up the present system telling the world that it can work again, just as it used to.

They want to convey that Greece, whatever the past hesitations, is now firmly under control and that there will be no contagion to banks exposed to Greek debt. They also want to convey that other at risk countries, namely Italy and Spain, have got their act together and will now enact policies aimed at reducing deficits and debt, therefore proving to the markets that they are reliable borrowers. To top it all off, Europe will also increase the firepower of its rescue mechanism, thus telling investors that, whatever may happen, sovereign debt will be somehow guaranteed.

Europe’s real issue is anemic growth

This is of course fine. Except for one basic fact. Europe is not having just a temporary liquidity crisis. Europe is revealing now the financial consequences of basic economic weaknesses caused by the bad combination of low economic growth, unaffordable welfare states and adverse demographic trends.

Put it simply, in several European countries structural debt is destined to stay dangerously high and possibly grow to unsustainable levels because they no longer produce enough wealth to finance costly public services and entitlement programs. In Greece we have seen the conflation of all these contradictions, magnified by Greek special features: namely massive tax evasion, bad work ethics and massive corruption.

Beyond a rescue plan, Greece needs to become a productive society

In fact, it is remarkable that the Greek farce lasted this long. Here is a mostly unproductive economy that collected little revenue, while most public employees did almost nothing and the rest of the working population did only a little.

This being the case, on top of a debt restructuring plan and a fiscal turnaround –difficult as these are– it is obvious that Greece needs a complete societal make over. If Greece, either with Prime Minister Papandreu or a new government, cannot manage to turn itself into a productive economy in which people are engaged in wealth producing activities that add real value, all the current EU efforts aimed at “saving Greece” are essentially meaningless. Bankruptcy or no bankruptcy, this is a country in decline.

Italy is in a dangerous zone

And the same applies to Italy and Spain. Italy’s gigantic public debt, (third largest in the world), is not a historical accident. For decades debt has been and is the way to finance unsustainable obligations made to public employees, pensioners and all sorts of other categories receiving direct and direct subsidies, while the productive economy advances at a very low speed.

Italy would need to dismantle the current welfare state in order to cut down future obligations. But even assuming such an unlikely radical political transformation, unless Italy moves into high gear and becomes productive, there is no way that this mountain of debt will be reduced. Let’s be realistic. The only way to get out of debt is to reduce current spending while increasing revenue, so that excessive debt can be progressively retired.

But with a feeble 1% or less growth there is no chance that Italy will be able to generate the additional revenue that would be required to start retiring this debt. Until now Italy counted on low interest rates that made it possible to service its debt without a Greek-like crisis. But if, new EU measures notwithstanding, the markets no longer buy the assumption that Italy is and will be solvent, it is the end. If the markets demand much higher interest rates to buy bonds, then the math no longer works. Italy can no longer service its debt and becomes another Greece. Ditto for Spain. And France is not too far behind.

Low European birth rates make everything more complicated

To this disconnect between high expenditures and low growth, do not forget to add adverse demographic trends. With the exception of France, there are few new babies in Europe. This means that the system to finance the welfare state can no longer work as designed. Working people pay into a system that transfers these moneys to the retirees. But now the pool of active people is shrinking, while the number of retirees grows. So, not enough money is generated to pay benefits. Unless fertility rates increase dramatically, this problem is fixable only by cutting payments to retirees or by mandating higher contributions for active workers. Either way, governments would get into a political bind, as people will be financially squeezed.

Parts of Europe in a phase of decline

In the end, either these European countries become vibrant economies capable of shedding all this debt, or all these EU measures promised today, even if we assume that they are seriously meant, will be for nothing.

The hard reality is that significant portions of Europe are not just going through a bad patch. They are in the midst of a systemic crisis –I call it terminal decline– that requires a lot more than EU rescue funds. Getting out of it would require a change of national ethos and a determination to reinvent societies. While this would be an extremely welcome transformation, it is so difficult to do that I am not sure that it is possible.




Europeans Agreed On Measures To End Debt Crisis – Greek Debt Will Be Reduced, Rescue Fund To Be Augmented, EU Banks To Increase Reserves – Yet Serious Doubts About Implementation – Italy’s Ability To Fulfil Obligations Openly Questioned By Partners

[the-subtitle ]

By Paolo von Schirach

October 27, 2011

WASHINGTON – The Europeans –at last– have put together the basic elements of a package aimed at restoring financial stability. Greek bond holders will take a major “hair cut” so that the level of the residual Athens’ debt will be reduced and become (hopefully) sustainable. The big European bail out fund, managed by the ESFF will be increased, while European banks will have to increase their reserves, in order to prove that they will be able to manage unforeseen crises.

Gap between EU members commitments and their ability to implement

So, all is well, finally? Not quite. As always, in EU matters, the devil is in the details. If history is to offer any guidance, in Europe there is usually a significant gap between broad agreements and implementation. And timing of course is another element.

And in Europe the big problem that the media and commentators keep omitting is that there is no European Federal Government that will take responsibility for anything. Let me repeat it: Europe is not a state. Do not be misled by the lofty sounding official denomination of “European Union”. Europe is not a politically unified state. It is a (complicated) set of arrangements among 27 sovereign states. The implementation of whatever is agreed to among the 27 is dependent on the will and good faith of the individual governments of these states.

Italy had to write to the EU that it can be trusted

Take Italy, for example. Prime Minister Berlusconi had to write a letter to the EU that opens with an odd statement whereby Italy is to be trusted to honor its commitments. Now, really. If you have to stipulate, in writing, to your partners that you are an honest guy, this means that they already assume (probably with cause) that you are not. And this shows the nature of the problem. Indeed, EU Commission President Jose’ Manuel Barroso stated that it is imperative for Italy to spell out its commitments regarding healing its own finances in a clear manner and with a precise implementation calendar. Some trust there. And Ezio Mauro, the editor of La Repubblica, an important Italian daily, commented that at this point unreliable Italy is in receivership. It has to be watched over by openly skeptical EU partners.

And, to make matters worse, the Berlusconi Government austerity commitments made to the EU partners have been openly attacked by the domestic oppositions and by all the trade unions who promise open battle against them. Some united Italian front.

And do not forget that Italy is no Greece. After Germany and France Italy is the third largest economy within the Eurozone. If Italy cannot manage to convince markets that its plans can and will its reduce its debt, then Europe’s troubles will not be over.

Are we getting to the end of the EU debt crisis?

With all this, are we getting to this end of this European drama? Well, yes and no. An agreement on reducing the total outstanding Greek debt is good news. And so is the deal about augmenting the size of the EU rescue fund and about larger bank reserves for European banks. (Please do keep in mind that these are the same banks that passed with flying colors a “stress test” only a few months ago). These are all good and reassuring decisions. However, they come late, after months of wrangling, and we have no guarantee of flawless implementation.

Individual EU members are politically weak

Look, if the Italians have to go to their EU partners with a letter in which they have to state that they can be trusted, this shows that the common European ground is shaky. And the fact is that, no, the Italians cannot be trusted, because Italy is a mess. It has a gigantic national debt, a weak economy and it is run by an equally weak Goverment with a razor thin majority, led by a Prime Minister who is on trial for a variety of criminal charges. The opposition demands Berlusconi’s resignation as a condition for supporting the majority’s reform package. This is a government that may be gone tomorrow, while there is no obvious replacement.

Given their internal semi-chaos, will the Italians in the end be able to do the right thing –cut spending, cut entitlements, liberalize the economy– in order to help themselves and Europe at the same time? Who knows, really.

After a two years crisis the Greek people have yet to embrace the new austerity policies

The Greeks have prolonged their own suffering by not doing the right thing. And they have been in this debt crisis swamp, entirely of their own making, since the end of 2009, when they announced to the their EU partners that they had cooked the books regarding the actual size of their deficits and that they were essentially broke. We are now at the end of 2011 and Greece, not at all out the woods, is being rescued once again by the Europeans who fear that a Greek disorderly bankruptcy would be a lot worse than imposing greater losses on banks and other institutions holding Greek debt.

So, luckily for Greece, their EU partners deem that Greece is too big to fail. However, the fact is that Germany and the other wealthier and better managed northern EU countries do not have enough funds (and will) to rescue everybody indefinitely. And this is why the EU authorities ask the Italians to provide a reliable implementation calendar for their promised austerity measures. But, as I said, when you get to the point that you have to ask a key partner to show you that they are serious, it may alreday be too late.

Ten years from now the EU may look different

Given this lack of an even elementary common ground among EU members, I suspect that something will have to give. I would not be surprised if, ten years from now, the EU will look different from what it is today. There are several current members that do not belong.




If There Is a Serious Crisis In Europe, Bad News for America – Economic Ties With Europe Are Huge – Problem Is That Washington Has No Tools To Protect US

[the-subtitle ]

By Paolo von Schirach

September 25, 2011

WASHINGTON – Washington is hopelessly divided, while America is economically very weak. Yesterday I expressed my hope that nothing bad would happen on the domestic or international economic front between now and the November 2012 elections. Indeed, if something major did happen, the US government has no wiggle room, no tools, no money and no united policy on just about anything.

Something bad happening in Europe

Well, I am afraid that something bad is really happening in Europe. If so, this new turmoil will hit America, turning a bad predicament into a real mess. Europe is in the middle of a confidence crisis on the reliability of sovereign debt, while the economies of many EU countries are sputtering, adding another layer of pessimism. If investors start running away from EU countries sovereign debt there is no way to predict what will happen next.

Europe is divided

On top of that, if Washington is divided, the 27 countries that make up the European Union, of which a critical subset are the 17 that belong to the Eurozone, are divided, confused, unrealistic, superficial, many of them led by uninspiring governments. If all this does not change, a weak, fractured and leaderless EU may very well wander into the abyss without even realizing it.

Inability to contain the greek crisis

But why all the pessimism? Well, the pessimism comes from observing the EU inability to isolate the Greek problem. As bad as Greece was two years ago, the EU could have built a fire wall around it. But it did not. Greece is bankrupt. But the other EU countries treated an insolvency problem as if it were a liquidity problem. So they provided more liquidity in exchange for promises of reform, privatizations and serious effort to improve tax collection, among other things.

Greeks broke and unserious

But the Greeks are both broke and unserious. They do not realise that it is their responsibility to spend less, work more, pay taxes and be frugal for many, many years. The Greeks dream. While the country is collapsing, the Greeks protest. They riot, they stage strikes in critical sectors demanding no cuts in salaries. Thy want to keep their benefits, pensions and what not. The point is, they never got the message. And the EU institutions, beyond the Papandreu government in Athens, are to blame for this disconnect and for failing to isolate the problem.

Confidence crisis spreading across Europe

But this is not even the half of it. EU policies failed to contain the damage beyond Greece. It is clear that Greek debt is held all over across Europe. Knowing this, investors, fearing an eventual Greek collapse, now are looking at German and French banks that hold a lot of Greek debt with increasing suspicion. And their doubts have just been confirmed by recent downgrades of major French banks by the rating agencies. And the downgraded banks have seen their stock sink, thus adding another layer of gloom.

Italy in the spotlight

As they are at it, investors begin to wonder how other highly indebted countries, such as Italy, will be able to meet their obligations. This new wave of skepticism regarding the quality of sovereign debt has already caused huge financial pain for Italy, Spain and even France. Investors are now afraid that all this debt may not be paid after all. So they demand higher interest rates to buy it. And this complicates debt financing for countries like Italy whose total debt now exceeds 120% of GDP.

If debt service becomes more and more expensive for the Berlusconi government in Rome, then the entire budget needs to be redone. And this turns an alreday precarious Italian debt management policy into a potential nightmare. Italy depended on low interest rates to keep financing its astronomic debt. If the cost of borrowing increases, then drastic spending cuts become the only alternative.

Banks holding government bonds are shunned

The trouble is that in weak economies drastic spending cuts have a recessionary impact. If you cut public spending to make debt service possible, you simply take some more oxygen out of the room, paradoxically making the debt problem even more severe. Meanwhile, the “Greek disease” has spread to other banks holding Italian debt. So, lack of confidence in sovereign debt issued by some EU countries is having a cascading effect. At some point, as financial institutions across Europe are all intertwined, there is a serious risk that nobody would trust anybody anymore, not knowing exactly who is healthy and who is affected by bad debt.

America should worry

But why should all this matter for America? Very simple. It does matter because the EU countries, in the aggregate, form the largest world economic block. If some European countries are in a serious crisis, while the damage cannot be credibly contained, we should expect a recession, or worse, in Europe. As Europe is a major trading partner for America, a collapse of economic activities and contraction of demand there would have very negative repercussions for US exporters already plagued by weak demand at home. If Europe contracts and stops buying, expect major US producers to cut production and, yes, employment here at home, making a tenous situation really bad.

Washington has no tools

Can America help in any of this? Not really. The problems are too big and the US has no tools left. Treasury Secretary Tim Geithner has said publicly that the Europeans should devise new policy mechanisms to harmonize fiscal policies and otherwise create ways to stop the impact of the Greek bleeding. But he also said that he is confident that the Europeans will do the right thing, as this is absolutely necessary. Geithner believes that the Europeans know exactly what needs to be done and now are just devising the appropriate political process to get it done.

Pray that the Europeans will do the right thing

Well, Geithner is correct. But he also really disingenuous in predicting that eventually the right thing will be done. This is just about the same as saying that both president Barack Obama and House Speaker Boehner know what needs to be done to fix US public spending and now are just figuring out how to get to a political agreement. Yes, the problem is finding a political formula. But, guess what, just as their ineffective Washington counterparts, the hapless Europeans are utterly incapable of agreeing on anything fast. And this is precisely the issue. Something needs to be done and it is not done.

No consensus, conflicting ideas

And so, German Chancellor Angela Merkel, French President Nicolas Sarkozy and all the others are circling around the problem with no new policy consensus in sight. In the meantime, in this policy vacuum, all sorts of conflicting ideas are floating. And this is damaging, as confusion reinforces the perception of disarray. Here are some samples:

Greece should stay within the Euro.

No Greece should get out.

There should be no Greek default.

No, we have to think of an “orderly restructuring” for Athens, (a polite way to say bankruptcy).

The Eurozone has too many undeserving members.

No, the Eurozone cannot be touched, as tinkering with it might cause the unraveling of the entire EU.

The European banks are in good shape, as they passed a “stress test” only a few months ago.

No, the “stress test” did not test much of anything, and thus it is inconsequential.

We trust the Italians to launch credible spending reforms that will stabilise their debt situation.

No, we do not trust them, as their government is led by Silvio Berlusconi, a perennially indicted Prime Minister surviving who knows how and happy to close each day while still in office. Besides, the Italian economy is not competitive and does not grow at all, not creating the surplus required to start paying back all that debt.

America bracing for the worst, with no protection

Given all the nasty stuff brewing in Europe, America should be prudent and prepare for the worst. The problem is, and Geithner knows it, that America is bracing for a possible hurricane with the protection of a few mended tents and not much else. The US shelters are under repair and we do not even have emergency rations, while the people in charge of operations are fighting one another.




Berlusconi Promises Tough Budget Measures For Italy – Attempt To Avert Greek Style Debt Crisis – Good Show, But Do Not Count On Structural Public Spending Reforms – Italian System Is Incapable

[the-subtitle ]

By Paolo von Schirach

August 15, 2011

WASHINGTON – The European Council President, Herman Van Rompuy, praised the Italian Government led by Prime Minister Silvio Berlusconi for its “timely and rigorous financial measures” aimed at reducing the government deficit as a way to contain the effects of the debt crisis. The measures announced are more stringent than a previous package which Rome announced only a few weeks ago.

Balance the budget?

Under the new plan, Italy aims to cut its deficit to only 1.4% of GDP in 2012 and balance the budget in 2013. This will be accomplished via a mix of spending cuts and tax increases. Why the new round of “rigorous” measures? Well, because the bond market had began wondering how Italy would ever pay back its astounding debt.

Unmanageable debt

Sure enough, until now Italy managed to service its debt, notwithstanding its staggering size, now more than 120% larger than the country’s GDP. But, in the midst of the growing Eurozone turmoil, caused in large part by market fears of huge piles of debt in many countries characterised by weak economies, Italy’s oversized debt looked very bad. And so investors started asking for higher interest rates for Italian bonds. And a rise in interest rates could be disastrous, given the size of Italy’s debt and the impact of higher interest rates on the yearly cost to service it. So, the European Central Bank, ECB, came to the rescue, buying Italian bonds, (and Spanish bonds, as Spain is also doing poorly), in order to alleviate the interest rate pressure.

In return for the favor, the ECB wanted Italy to show more forcefulness in spending cuts as a demonstration that the country is well on its way to balance the budget, and very soon capable of generating budget surpluses, so that it can credibly show that it is has a strategy to start retiring this enormous debt.

Italy “does not do” long term plans

Well, here I invite a pause. Such a transformation in Italy’s fiscal policies would be a revolution. In size and scope this would be totally unprecedented. Italy “does not do” long term strategies. It never did. And I suspect it never will. The political system was and is paralysed. Silvio Berlusconi, haunted by criminal prosecutions and even sex scandals, is a totally discredited leader attacked from within his shaky coalition. And there is no credible center left political alternative.

Everybody is wedded to the system as is

Besides, whatever their politics, the Italians are wedded to a costly and ineffective welfare system. And the Italian economy is strangled by bad laws and extremely onerous labor regulations. Some Italians reacted to this through the “grey economy”, also known as “the submerged” sector, (no invoices, no records, no taxes). Organised crime, through its main “holding companies”: Mafia, Camorra and N’drangheta feeds on all these structural inefficiencies, collecting rents at every step of the way.

A “rigorous” plan would entail trasnforming all this, so that –puff– the old Italy is gone and a new one born. So, please, forget about it. With this I do not mean to say that nothing will be done in Italy. “Something” will be done, for sure. But count on cosmetic, mostly window dressing, temporary stuff.

Count on clever moves

Italy is famous for last minute improvisations and clever manoeuvres. But, serious, structural reforms are too complicated in a country kept together by layers upon layers of interlocked vested interests and where it is a remarkable political achievements to survive the day.

And, please do remember that Prime Minister Silvio Berlusconi himself came onto the Italian political scene as the anti-establishment “new man”, a self-made businessman who would finally introduce sound market oriented economic policies. Well, this was back in 1994. And while lucky enough to govern with a large majority, at least after the most recent elections, he did basically nothing.

But now it is different, bold action needed

One might object that now the situation is different, as Italy is confronted with a fate similar to Greece, unless drastic action is taken right now. Well, you would think so. But I doubt it.

Look, even Greece, a Eurozone country that did fall into the abyss and is now in the midst of a real national tragedy, still does not get it. The Greek Government is still a long way from having all its citizens buy into a real reform plan. Mostly the Greeks resist the changes enacted to save it.

Italians still believe that they will get by

The Italians, who want to believe that their predicament is not as bad as Greece’s, are even farther away from buying into anything. For sure, to assuage the markets, “something” will be done. Hence Rome’s policy announcements. But do not expect any serious, radical and implementable long term plan. This would be way beyond what a weak political system can design, sell and execute.

The EU partners know this

So, to read today that Italy’s new initiatives are regarded as “timely” and “rigorous” by its EU partners makes me wonder. Don’t the other Europeans know that this is going to be some more Italian window dressing, with little substance? My hunch is that probably they do know. Still, it is expedient to say nice things in public, hoping that the bond markets will be fooled. After all, last year when the Greeks promised to put their house in order, in return for EU and IMF money, nobody doubted their intentions in public. And then we saw what happened.

Proclivity for farce

This proclivity for farce makes me think. It used to be said about Italy that “The situation is dramatic….but not serious”. Now, if the other Europeans play along and accept Italian smoke and mirrors as substance, I am beginning to think that this sarcastic characterization of basic lack of seriousness applies to the rest of Europe as well.




Wall Street Mini Crash, Turmoil in Europe Indicate No Faith in Western Countries Economic Policies – Cost Of Welfare State Coupled With Weak Economies Caused Unsustainable Debt – We Need New Pro-Growth Economic Strategies

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By Paolo von Schirach

August 5, 2011

WASHINGTON – Whatever the mini stock market crash, ( minus 512 point for the Dow Jones), of Thursday August 4 was, it was not a sign of confidence in the economic foundations of worn out, short of breath Western countries. Who knows what exactly caused a moment of panic and this significant stock market sell off. But one thing is clear: neither in Europe nor in the US the economic and economic policy fundamentals look particularly inspiring. On both sides of the Atlantic we have now a nasty combination of slow economies and huge entitlement obligations, accumulated over decades, that created an enormous debt burden, suffocating public finances.

Vote of no confidence, Italy weak link

In an emotional, panicky, moment markets simply expressed a vote of no confidence in Western public policy as currently structured. Their verdict: No way that anybody can sustain, let alone pay back, this kind of (growing) debt without any significant economic expansion. In Europe now it looks as if Italy, (the world’s 8th largest economy), is the new weak link –and a big one, compared to tiny Greece that has been making headlines for months. And concern is with cause.

While the yearly budget deficits are not staggering, (thanks to the efforts of Economics Minister Giulio Tremonti), Italy’s total debt, at about 125% of GDP is huge –and the economy is not growing. So investors started wondering how will Italy manage to carry this enormous debt burden without the ability of generating the extra revenue that could allow debt repayment, while also meeting ordinary expenses. Their skepticism is expressed first of all in asking for higher interest rates when lending new money. And this is of course very bad, as it increases the debt service cost of the existing national debt, increasing the strain on already strapped public finances.

Needed: a new course

What markets –and Western societies– badly need now is bold new leadership that would admit failure of this model and propose a radical change of course, away from more and more welfare and focused on growth. But I would not count on it. Politics in both Europe and the US is about giving things to people who have come to expect hand outs in the form of entitlement programs as civil rights. All well and good if these hand outs were free. But they are not. Hence the disconnect between large promises made and revenue shortfalls that manifests itself in mountains of debt. Without changing course, it is obvious that governments will be unable to keep their promises, while the economies will be crushed by debt.

US: dismal growth, no debt reduction plan

In the US, we just had a puny mini August 2 debt deal that means nothing, while new data indicate dismal economic growth, (less than 1% so far this year), and only modest employment growth: 117,000 new jobs in July. The general consensus is that we would need sustained 2 to 3% growth and 200,000 new jobs every month to get more revenue and start mopping up the 9.1% unemployment rate. And the US, while not in desperate conditions when it comes to servicing its debt, has yet to put together any credible plan that would convince markets as to its determination and ability to really reduce federal spending, if not now, at some point.

While it is extremely difficult for Washington to engineer an economic growth strategy in a country in which tens of millions of people are laboring to get out of debt and thus are unable to fuel demand through their very modest spending, there is absolutely no action plan to do anything worthwhile.

Do something: promote domestic energy exploration

One idea? Start by focusing on boosting supply of domestic energy. Make it easy to have more exploration for oil and gas. Create more downstream opportunities for new sources. America is lucky enough to have found out how to exploit huge reserves of shale gas. Well, let’s use this gas for transportation as well as electric power generation and feed stock for the chemical industry. Let’s create a new domestic truck and auto industry of gas powered vehicles. T. Boone Pickens has been promoting this idea for years.

Exploit all natural gas opportunities

The economics are good. Natural gas is much cheaper than gasoline. And gas is domestic, not imported. We keep our money here and we invest it here, this way creating new jobs in America both in energy production and in the vast supply chain that feeds the industry. This is bound to be good for new employment and growth, while it would improve our balance of payments, as we would end up importing less oil.

Infrastructure maintenance plan

Look, this is just one idea. We have also heard about a massive national plan to hire people to execute badly needed infrastructure maintenance. This is not about new projects that would need time consuming vetting and permits. This is ordinary stuff: highway repairs and the like. But these are essential interventions, absolutely necessary just to keep the integrity of our national physical plant. Former Pennsylvania Governor Ed Rendell talks about it on TV. It may not be panacea. But it will put people to work, while performing repairs that are needed anyway, with obvious benefits for commerce and overall economic productivity.

This is urgent

But president Barack Obama, while proposing the creation of a National Infrastructure Bank, is not providing the leadership needed here. There is urgency about doing whatever is reasonable to get the economy moving. And the White House is not conveying this urgency. No wonder markets are pessimistic.




S&P Downgraded Italy to Negative – Cites Inability to Tackle Debt Now at 125% of GDP

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By Paolo von Schirach

May 21, 2011

WASHINGTON– The list of sick Euro-zone countries, comprising now Greece, (just readmitted to the financial rescue ward), Ireland and Portugal may soon comprise Italy as well, even if just an out patient. Standard & Poor’s just changed its outlook for Italy from “stable” to “negative”. The S&P A+ rating for Italy’s debt has not been changed. But it may be changed later on, if the rating agency does not see real progress in tackling the enormous Italian national debt, amounting now to 125% of GDP.

Weak economy, unstable government

It is true that the Italian Government has been relatively good at containing the annual deficit and thus the rate of growth of the overall debt. However, S&P notes a negative combination of structural economic weaknesses and political gridlock in Rome as factors inhibiting growth. The country would need a much more dynamic economy in order to generate the surplus necessary to start paying back at least some of its debt. So, Italy at the moment is not a candidate for intensive therapy by the EU and the European Central Bank. But, unless more vigorous pro-growth policies are enacted, it may become one.

Rome: not rue, government strong

The Italian Ministry of the Economy replied to this downgrade by stating that Italy will fulfil all its obligations and that there is no risk of political gridlock in Rome. Now, the latter point is a bit optimistic, if not preposterous. The ruling center-right coalition presided over by Prime Minister Silvio Berlusconi, barely survived a split and a recent no-confidence vote by a very thin margin in the Lower House. The Prime Minister spends time in court defending himself in a variety of trials. The coalition lost votes in recent local elections. While the Government is still there, it is not solid; and it is unlikely that relying only on this unstable base it can launch far reaching economic policy reforms.

Italy is not competitive

Italy is not very competitive and there is nothing that would indicate higher productivity in the years ahead. It is also believed that existing economic plans, as envisaged by existing government policies, will be unable to stimulate the economy. S&P is concerned that gridlock and political weakness at the top would make it more difficult for Rome to muster the consensus necessary to reduce public debt. If growth is even lower than the currently estimated 1.3%, in the 2011-2014 time frame, then we can expect lower revenue and inability to pay back more debt.

Long term, demographic trends also look very unfavorable. Italy has one of the lowest fertility rates among developed countries, (1.39 children per woman). Over time, this means fewer active people paying taxes and more retirees collecting benefits; thus progressively increasing the financial weight of entitlement programs for seniors on the rest of the economy. This is no recipe for lowering public spending.

The Government firmly denies any real deterioration that would support a change of outlook to “negative” on the part of S%P. They cite reforms, tax credits for setting up new businesses and more positive steps that would improve the fiscal outlook. But all this is unlikely. The Italians are experts at walking the tightrope. And this Government has managed to avoid disaster by tightening fiscal policies and thus annual deficits.

Italy needs structural economic reforms

Still, the structural shortcoming is Italy’s lack of overall competitiveness, while the enormous national debt overhang slows everything down even more. A very dynamic government, enjoying a vast consensus for reforms aimed at making the country nimble, could start a turn around process. But there is no such thing. If the center-right coalition supporting Berlusconi does not collapse, the present government may be able to hold this together for a while. If this government does not last, not much hope for a dispirited and disorganised opposition to take the lead on the economy. Italy’s outlook, while not disastrous a la Greece, is neither good nor promising.