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The Banking risis and the Euro DAS euro BOOT τΑ κατΩ Krise: Banking, Trade & Growth? Robert McDowell Banking Expert & Macroeconomist (Edinburgh) Freudenstadt Konferenz 2-4 July 2010

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Page 1: Das Euro Boot Take Away Copy

The Banking €risis and the Euro

DAS euro BOOT

τὸ Α καὶ τὸ Ω € Krise: Banking, Trade & Growth?

Robert McDowellBanking Expert & Macroeconomist (Edinburgh)

貴社ますますご盛栄のこととお慶び申し上げます。平素は格別のご高配を賜り、厚く御礼申し上げます。

Freudenstadt Konferenz 2-4 July 2010

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DAS euro BOOT Krise ?Airlock panic

• EA sub stuck in ocean mud: who can escape via the airlock?

• Or, who or what can be jettisoned out the torpedo tubes?

• Break-up of Euro: stories start flooding in January 2010

• March: „Die Griechen sollten den Euro verlassen?“

• FT: Greece‟s best option: default & leave ?

• May-July: FT posits Germany leaving EA !

• Soros: rät Deutschland zu einem Austritt aus der Euro-Zone

• Sarkozy: a menacé de sortir la France de l’euro pour sauver la Grèce, selon Zapatero, cité par El Pais

• Jean-Claude Trichet: “world faces a second Lehman” hours before EU leaders launched their €720bn (£612bn) defence fund. If ECB President is correct, we are in trouble (Daily Telegraph).

• “EU-IMF package unraveling. What will West do next?”

• June: Die Welt: “Deutschland sollte die Währungsunion verlassen „?

• Panic ? = safety within borders? „every man (state) for himself“!

I

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LOGGED IN THE WARD ROOM

1. EU/EA Stabilisation fond?

• Haiku van Rompuy*/ plus heads of state 7th May/ meet a new deal to agree

• President Rompuy/ & 3 Spanish econ grads/ PR 2 am, 10th May

• Announce fund set up/ €720 billions/ for state-aid loan grant bail-outs

• SPV format/ Bankruptcy Remote concept?/ to assure wolfpack markets?

• Big as an IMF if/ but no board, bank account, or…/ vaunting Barroso** power?

• Normally takes years/ e.g. EIB – EBRD / guile sans skill: amateur hour!

• Sub-rosa: it‟s TARP again/ will MEPs play Congress/ vote a slice plus oversight?

____________________________________________________________

* Van Rompuy Presidency 2009-2012

Invented “asymmetrical translation” e.g. European Council = "le gouvernement économique“ / "economic governance"

** Barroso Commission 2004 -2014 incompetently desperate to get hold of a major reserve fund

II

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Wolf pack v. euroConvoyAtlantic War new game version?

• Market Speculators „Wolf Pack“• $tens billions of profit plays• Players choose save or destroy € euro-system• Investors briefings on € /EA break-up:

– Sell Belgium, Spain, Greece, Portugal stocks– Buy Bunds, sell Dax (DM? Exports )– Buy Italian stocks (Lira? Exports )– France neutral (hold, subject to downward revision)– Buy $, £ (safe havens) &– leverage & arbitrage derivatives & shorting Euro & banks: big money

gains for hedge funds?

III

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EU/EA crisis

a crisis of mixed metaphors

• EU 3 P‟s: Prejudice, Prudence, or Profligacy?

• EU 3 C‟s: Capital, Credit, or Competitiveness?• EU 3 B‟s: Budget, Balance, or Bankruptcy?

• not about moral virtues (that‟s callous political spin)

• it‟s EU jigsaw of trade, payments & bank lending • each member finds its own efficient growth path• they cannot all follow export-led or credit boom or a mix

• EU = different economies united, not a single economy!

• EU/EA system has to embrace economic risk diversity!• EU/EA is world economy scaled 1/3; it is not a single economy state

IV

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Eine Reise ans Ende des Verständnis

6

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Provocations 1

POLITICAL-ECONOMICS IS A SCIENCE… OF PROPAGANDA OTHERWISE IT IS A SOCIAL SCIENCE

SYSTEM OF ECONOMIC ACCOUNTING

• Public finances are not “in a mess” !

• …unless private finances are a Greek Tragedy?

• Countries perforce have different growth strategies

• Export-led growth forces others into credit-boom & vice versa

– New fashion ignored external accounts & their financing for „money supply‟

(so-called „new paradigm‟ for growth = „credit-boom‟ growth?)

– Extreme imbalances in world trade: credit-boom / export-led economies = net financial assets = payments deficit/surplus = pay for trade deficits & finance credit boom = asset bubbles & growing banks‟ funding gaps

– High bank funding cost wiped out net interest income = Credit Crunch

= trigger of Anglo-Saxon recession & temporary global shock

1a

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Provocations 2

• Bank lending patterns dictate GDP growth strategies• Economies not made safe merely by balanced budgets!• Crowding Out theory = myth of public/private competition• Other „crowding out‟ = real problems in composition of bank

lending: earnings v. property as borrower collateral• Lower public deficits = lower private surpluses• Micro-model theories = macro-stupid!• Savings, growth, competitiveness, productivity, & zero-sum

ideas are entirely different at– macro & micro levels– domestic & international levels

1b

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In the Conning tower

• PRIMITIVE visual GUIDANCE CONTROL SYSTEM

• Authorities* have no macro-economic models for analysing Finance in detail!

• Basel II tasked banks to build such systems; they didn‟t, couldn‟t, wouldn‟t!

• For factors– Dictating the Credit Crunch or

– Measuring interventions or

– Understanding banks in economies, or

– Income, trade, payments in growth!

• & not now (despite G20 tasks that assume such models exist!)

• Most effort is in behavioural games theory models!

• Economics as double-entry accounting standards was lost to politics

• Econ teaching is empirically poor, math-algorithmic absurd bubble!

• Mythos of “hard choices”: but can refinancing & recovery be self-financing?

• Governments cannot agree a self-financing painless path?

_________________________________________________________

* Central banks, government finance ministries, regulators, major banks, NGO banks2

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Multi-national sovereignEURO SYSTEM DESIGNED TO BE PROOF AGAINST MARKETS

NOW DEPTH CHARGED by markets & gunslinger politicians

Causes- Not GOVERNMENT DEBTS (political not technical problems)- OPPOSING (complementary) INTRA-EU external accounts- CREDIT BOOM v. EXPORT-LED v. MIXED MODERATE states

Effects- PIGS‟ external deficits cannot be funded without fiscal austerity?- Bond markets impose higher margins on CB deficit states &- countervailing v.low margins on external EL surplus states- Credit-Crunch scandal effectively replayed at Governments - hits banks again & other sectors but now per sovereign borders.

3

EURO SYSTEM-KRISE

Maastricht SGP too crude

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ENGINE ROOM ENGINE ROOM

BLINDBLIND OR BLINKEOR BLINKERED?RED??

4

Traditional economists’ view:

financial sector should not have macro-economic significance

Is this- MAD, LAZY, FOOLISH, DANGEROUS and/or

Irresponsible- BANKS DIDN‟T KNOW OR CARE EITHER WAY !

Regulation- BASEL II brilliantly DESIGNED TO CURE THIS, BUT PILLAR II of it NOT COMPLETED BY ANY BANKS!

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WHO SETS COURSE HEADINGS?

5

Composition of bank lending reflects, causes & amplifies a country‟s growth choice (export-led EL, credit-boom, CB or a mix?)(Not discussed in debates among economists, regulators, governments, or media. )

Export-led Germany & others (also China): 60% lending to business, capital investment & trade = low consumer & mortgage lending.

High deficit credit-boomers: UK, Greece and Spain, banks‟ customer lending is 60-70% to mortgages & property (also USA).

Bank lending in both EL & CB states is risky because banks do not diversify across whole economy.

Bank balance sheets are as fragile in EL as in CB countries!

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UK & De bank lending

„crowding out’ in bank lending?

4

UK customer loans = 165% /GDP ratio (€2.5tn, $3.5tn)

De customer loans = 78% /GDP ratio (€2.3tn, $3.2tn)

UK mortgages ($2.1tn) = 58% of loans, > 75% residential

De mortgages = ($1.53tn) = 44% of loans, < 50% residential

UK h‟hold loans ($1.95tn) = 55% of loans (87% / GDP)

De h‟hold loans ($1.39tn) = 55% of loans (43% / GDP)

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Bank credit support

or not for

INDUSTRY & TRADE?

5

UK loans businesses = 45% customer loans (but 50% = com. mortgages & property)UK non-property loans = 23% of cust. loans or 37% /GDP.De loans to industry = 56% or 44% / GDP of which 25% is mortgages/property.

UK tradable goods industry sectors get bank credit = 5% /GDPDe industry loans = 33% /GDP, of which tradable goods = 30% /GDP

UK (non-financial) business output = £590bn (£300bn services, £290bn industry, of which manufacturing £240bn). nf all business incl. services bank borrowing = £900bn = 152% /sector GDP, or 76% ratio (excluding commercial mortgages )

De domestic bank credit excl. mortgages to German industry = 163% of sector GDP UK figure is 76% of industry sector GDP.

UK banks extend $100bn of credit to support $350bn exports = 28% ratioDe banks extend $620bn credit supporting $1.5tn exports = 41% ratio

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Debt burden on De industry

& banks

6

High exposure by DeDe banks to industry (business loans are lowest margins) = DeDe sovereign debt spreads v. critical to banks‟ net interest income = in EA sovereign debt crisis

DeDe priority = De De sovereign debt needs far lower risk margin than other EU sovereigns! Or, banks & corporates risk insolvency losses.

LOGIC BEHIND MERKEL‟S TOUGH-LOVE STANCE IN

EA SOVEREIGN DEBT DISPUTE?

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DeDe BANKS VULNERABLE TO CREDIT DEFAULTS AS TRADE & MARGINS FALL & BANKS TO REFINANCE €0.5tn IF CANNOT

GET LOWEST RATES!?

7

DeDe industry's debts= 160% /industry’s gross outputDeDe industry debt servicing =10% / gross operating surplusGDP forecasts are 1/3 lower than UK

UK industry debt servicing = 4% / gross operating surplus,Debt servicing for all UK business = 13% /profit in ‟08 & 9% in ‟09GDP forecasts are sharply higher than DeDe

In „04-‟08 EL‟s GDP grew fastestnow endogenous CB‟s GDP higher in medium term… except EA‟s PIIGS!

Die Die HeimatHeimat gefährdetgefährdet ??

Sovereign bonds spreads & yields for years 2007 –2010 /German

Bund

Sovereign debt prices directly influence banks‟ & corporates‟ credit status & debt costs, not just government borrowing cost!

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De in EUEU/EA/EA

9

De trade & surplus = same size as China‟s60% is intra-EU but De ex-EU trade surplus halves EU external deficit

De in EAnf private sector lending = 22% of EA totalLending to business = 25% of EA total nf customer lending = 21% of EA total

despite nf private customer lending in EA = 107%/GDP compared to De = 78% /GDP

De economy in EA is like USA % in worldUSA in the world is an extreme credit boom economyDe in Europe is an extreme export-led economy____________________________________________________nf = non-finance sector (business excluding banks etc.)

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Greece extreme credit boomer

10

0

5

10

15

20

25

30

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

Greek Banks' Loans by Sector as % ratios to GDP

Tourism Services Industry Shipping

Consumer Other Personal Res.Housing Finance

GREECE FOLLOWED

OTHERS „ MODELS -IRELAND, UK, USA, SPAIN & PRAISED IN EU

FOR HIGH GROWTH

CONTRIBUTION TO EU

FOR YEARS!

RECESSION WIPED OUT

90% OF GREEK BANK

CAPITAL. BUT THAT IS ON

A PAR WITH UK, USA, OTHERS‟ BANK CAPITAL

IMPACTS.

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Competitiveness: reality & illusion

11-150

-125

-100

-75

-50

-25

0

25

50

75

100

125

150

175

200

225

250

275

2007 2008 2009

GERMANY

FRANCE

UK

ITALY

SPAIN

NETHERLANDS

POLAND

AUSTRIA

DENMARK

GREECE

PORTUGAL

FINLAND

IRELAND

CZECH

SLOVAKIA

LUXEMBOURG

-100

-75

-50

-25

0

25

50

75

100

125

150

175

200

225

250

275

300

2007 2008 2009

GERMANY

FRANCE

UK

ITALY

SPAIN

NETHERLANDS

POLAND

AUSTRIA

DENMARK

GREECE

PORTUGAL

FINLAND

IRELAND

CZECH

SLOVAKIA

LUXEMBOURG

EU Trade Balances$ billions

EU Balance of Payments

$ billions

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Credit boom V. export led

12

14000

15000

16000

17000

18000

19000

20000

2005 2006 2007 2008 2009

CB

EL

GDP of 6 Credit Boom CB economies incl. USA and UK v. GDP of 10 Export Led EL economies incl. Japan, Germany &China.$ billions

credit-boom: USA, UK, Spain, others

export-led: China, Germany, Saudi Arabia, Netherlands, Russia, S.Korea, others

modest mix: France, Italy, Belgium, Switzerland, RSA, Mexico, othersstrong mix: India, Brazil, others

0

10,000

20,000

30,000

40,000

50,000

60,000

2000 2002 2003 2004 2005 2006 2007 2008

Households

Non-financial business

All public sector

Financial firms

Rest of the world

$ Bn US banks flowof funds by sector

Note dependence of inter-bank lending in USA to household mortgage and consumer lending.The opposite prevails in export-led where inter-bank lending is tied to business lending.

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COMPARING BANK LENDINGUSA & prCHINA

13

$ trillion roundedDec.’09 % GDP

Bank & other lending 21.3 150Financial 4.0

Enterprises 4.84.8Loans & corp. bonds 3.2

Commercial mortgages 1.6

Real estate 2.6

Households 14.0 102Of which mortgages 10.8

Consumer credit & lease finance 3.2

Bank & Other Liabilities 21.3 150Non-financial Deposits 7.3 50

Money Market depos 3.0

Trading 0.8

Central bank 2.3

Other 2.6

Banks reserve capital 1.1Equity 1.5

Inter-bank debt 3.7

$ trillion rounded Dec.’09

%

Increase

in ‘09

Bank Deposits 9 27.7

Of which: By enterprises 3.3 36.5

By households 3.9 19.5

Of which: Rmb

Deposits 3.8 19.7

By Government1.8

Foreign

currency

Bank Lending 6.36.3 33.0

Of which: Short-term 2.2 17.7

longer-term3.5 43.5

FC Reserve loaned to banks 2.4 600Other 0.6

Of which: Enterprises 4.84.8

Households 1.2

Other 0.3

USA economy 5-7 times bigger than PR China (depending on whose adjusted GDP figures)USA bank lending = 150%/GDP, China = 2-300%/GDP. China lending to industry (half of which is funded by loans of

all of China‟s foreign reserves) matches the total for the USA i.e. China‟s industry is severely over-borrowed and the economy is vulnerable to downturn in world trade and fall in net exports (& commercial property collapse?).

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Some more comparisons

14

USAUSA65% of credit to households,22% to medium & large Enterprises10% to small firms incl. self-employed.70% of total exposure is property-related,This chimes with UK, Spain, Greece, Ireland.

PR CHINA75% loans to business19% to householdsnf firms debt =173% /total outputNet debt of enterprises =114% /output!Households borrow 30% of h‟hold deposits.

UK & USAUSA lending to h‟holds = 100%/GDPof which 70% = residential mortgages

China h‟hold loans =25%/GDP mortgage & consumer finance are small.

UK banks lend too much to h‟holds for property (70% /total customer loans) Manufacturing (17%/GDP export 13%/GDP) =3.5% business loans (1.5%/GDP) Construction (5%/GDP) = 4.5% /business loans (=2%/GDP)Small firms & self employed get 1.5% of all loans yet employ 50% priv. sector jobs!

GermanGerman banks loan too much to industry at 56% / total customer lending29% /business loans are to small firms & self-employed =10 x UK %.

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Back to port sovereign debt &

Euro system 1

15

Banks & EU states need government borrowing to - boost private sector assets & reflate economies- improve quality & quantity of banks‟ capital reserves- finance trade deficits

Fiscal & Monetary measures - are clutch & accelerator pedals, not steering wheel- do not restructure, or- change type of economic growth direction- we leave steering to banks & free market - who do not navigate on basis of national macro economics

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Back to port sovereign debt & Euro system II

15

Maastricht Criteria /EU’s Growth & Stability Pact

- Ceilings & hurdles to cap member states‟ borrowingin reference only to GDP ratios !

- Other factors ignored incl. bal. of payments (anomaly Ireland: economy far smaller than its GDP?)

- Only gross not net National Debt- Deficit & debt ratios scaled to GDP (not GNP) &

don‟t take account of ext. trade & payments(supposed benign intra-EA & EU but Greece shows not so)

- Ignores currency of debt & private debt levels, & domestic versus foreign ownership of debt (EA=domestic?)

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Back to port sovereign debt & Euro system III

15

Solving EU/EA Sovereign Debt Crisis requires system to:- Recognise differing/opposing growth stances e.g. CB & EL, &- Intra-EU/EA imbalances, on & off government budgets- Regulatory supervision to compel banks to rebalance lending.- Does not directly require aligning tax or fiscal stances.

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Concludings A-E (time permitting?)

unsere Krise riskiert eine riesigeSicherheitskatastrophe

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A

•• DeDe was in heart of EUEU, „generous’ to secure Europe.

•• DeDe is the protagonist in Euro Krise, bringing integration into a crunching of gears.

• € incomplete : monetary union sans political union, ECBsans central treasury (not insoluble).

•• EAEA states are alone on sovereign debt weakened sanstreasury money market flexibility.

•• ECBECB accepts sovereign debt of all EAEA equally, same interest rate as Germany, but not a solution.

• Banks loaded up with PIIGSPIIGS‟ debt until 2010.

A

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B

• After Sept. „08, EUEU Council guarantee no big banks will default. DeDe insists each state to care for its own.

• Capital moves with guarantees, interest-rate differences in EAEA stay small.

• Hungary & Baltic states rescued.• As markets cage-rattle sovereign debt, interest-rate

differentials widen. •• GreeceGreece the battleground.•• EUEU authorities slow. EAEA members hold opposing views.•• DeDe insists on S&GS&G Pact‟s Pact‟s “no bail-outs”.•• GreekGreek crisis festers, contagion spreads.

B

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C

•• EUEU forced into bigger rescue package than if it‟d reacted quicker.

• Markets see terms as punitive, fiscal consolidation harder, can‟t see how PIIGSPIIGS can fly:

• Close trade deficits & revive growth sans currency depreciation? (Euro system break-up) or risk deflation.

• Can push EUEU into long stagnation (late „90s early „00s) = social unrest (at worst, xenophobic extremism).

•• DeDe has major responsibility as biggest trade surplus, most creditworthy country (externally, not internally)

C

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D

•• DeDe unwittingly imposes deflation on EAEA (itself included & next recession imminent).

•• DeDe public cannot see the harm because of how the €works. Soros says, “deflation will serve to make Germany more competitive on world markets, while pushing the weaker countries further into depression and increasing the burden of their debt”.

• No, this is a two-sided coin; DeDe will also fall.

D

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E

• If DeDe left €, Dm would soar, €€ & DeDe exports plummet.

•• Rest of Europe Rest of Europe more competitive to grow its way out but Germany crucified by overvalued currency (like Japan).

•• DeDe trade balance evaporates, businesses default & unemployment soars (extreme political crisis).

•• DeDe Banks require v.large injections of gov. funds.

• Hypothetical - if DeDe left €€, consequences are immense, unthinkable beyond making sure this cannot happen!

E

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€€ötterdämmerungötterdämmerung darfdarf nichtnicht wahrwahr seinsein

schonschon amam EndeEnde vomvom €€uro BOOT?uro BOOT?