Courtesy of Gabe Aguilera comes a great work of art courtesy of the Mexican loss to Holland in the World Cup. Great art can come from defeat.
NSFW. Seriously: very Not Safe For Work.
The Trans-Adriatic Pipeline (TAP) is a project that will connect Azeri natural gas with Italian markets. The gas from the Shah Deniz field will pass through the Trans-Anatolian Pipeline (a different project) and then connect into the Trans-Adriatic at Kipoi, on the Greco-Turkish border. The pipeline will then go through Greece and Albania before plunging under the sea to end in Brindisi, Italy.
Press accounts have made much of the transit fees that will go to countries like Greece.* From the link: “With the economic crisis in Greece, TAP promises the added benefit of funneling billions of euros from transit fees into the Greek economy.” Moreover, Montenegro expects to earn €30 million per year from a possible northern extension of the pipeline.
We fully expected that Albania would be earning fees., although we had heard credible rumors that they would be paid in molecules of gas rather than currency. In fact, we came up with a business plan to attract investment into thermal generation based on the idea.
So we were stunned when the CEO of the national generator, Kesh, told us that Albania was getting nothing but the option to buy some of the gas at market prices. He said that when the Albanian negotiators raised the issue, the pipeline consortium threatened to go through Greece. That seemed like an amazing failure of diplomacy. After all, Greece had nothing to gain by denying the Albanians their fees. Greece would not get them either; why screw over your poorer neighbor?
But then we learned that there was a wrinkle: Greece will get no transit fees either.
Why not? Well, a member of the European parliament asked that very question. The answer: European Union rules prohibit governments from charging transit fees. The reason for that makes sense: special transit fees above-and-beyond those charged commercially would be a restraint on trade.
And that is why Albania won’t get any fees. It is true that the Greek government might stiff Albania out of spite. (The two governments are involved in a spat over their exclusive economic zones in the Adriatic. And place names. And the Chams. See here for more.)
But it is also true that Albania wants into the European Union. And that means complying with E.U. rules even if they don’t have to. So no transit fees, no free gas. Just a commercial operation on Albanian soil.
In other words, a nice thing for Albania, but not a panacea for its energy problems. Oh well. Back to work!
Much has been made of this Brookings Institution report showing that Americans are starting new businesses at a much slower rate than before.
The reason for the decline? We don’t know for sure, but the consensus seems to be the rise of the chains and the Internet. (Actually, that should be chains or the Internet; one might be more important than the other ... and the pre-Great Recession timing strongly suggests a late-1980s victory of the franchise.)
It isn’t a bad case. Here is the gist:
These are reasonable points. But they have to overcome one piece of evidence:
(Data from here.)
Incomes really haven’t budged for anybody in the lower 95% since 1987, save for a brief period in the late 1990s. If the triumph of the chains really were all that, then one would expect to see the opposite, no? Ditto if the growth of winner start-ups trickled down to the average American in any sort of direct fashion.
Sadly, however, all we see is stagnation. This puts the burden of proof back on Jordan Weissmann; an unsubstantiated dig at Italy for combining economic failure with lots of mom-and-pop shops doesn’t convince, because it is not clear to me either that Italy has lots of mom-and-pop shops or that they are the cause of the country’s recent stagnation.
Still, it is possible that the rise of the chains prevented the stagnation in American living standards from being even worse. Perhaps they increased labor demand, paying above-median wages and only following other establishments down after their wages dropped. Or perhaps they offered cheaper goods on a large-enough scale to cushion income declines.
That should be testable. Has anyone tested it?
I have to admit that my first thought upon reading this heading, “Putin Aims His Energy Weapon At Ukraine,” was not “lasers!” That was my second thought.
Anyway, if the article had stopped there, with that sentence, I would not be writing this. Unfortunately it went to argue that Russian gas price hikes against Ukraine might not work because winter is ending and Europe is more resilient than it used to be. Note how the author dropped any discussion of the effect of a price hike on Ukraine.
I humbly submit that the fact that Europe is relatively invulnerable to a gas cut-off right now is a feature, not a bug. It means that the Russians can extract rents from Ukraine and cut them off if they don’t pay without worrying about European public opinion. (In the short-run, Gazprom’s contracts mean that in the absence of official sanctions Western customers will pay even if they cannot take possession of the gas.)
If Ukraine pays, it will hurt. The rise is from $8.38 per MMBTU to $15.18. In 2012, Ukraine imported 1.2 billion MMBTUs ... putting the additional cost in the order of $9 billion. That will hurt. Even if Ukraine can keep reducing its gas consumption, that will hurt. And if the taps are shut off because Ukraine doesn’t pay, that will hurt more. As the above-linked article points out, E.U. countries can ship enough gas to Ukraine to meet about 25 percent of its summertime demand, but that’s it ... and we don’t know at what price. (There is more pipeline capacity to Ukraine, but Gazprom controls them. Which means that it won’t allow gas to flow eastwards unless European governments expropriate the Russian company.)
In short, I have no idea why the article was subtitled, “Moscow is jacking up gas prices to cow Kiev and scare Europe. It may not work this time.” It may not scare Europe and it may not cow Kiev, but neither is the point.
Last point: you have to love the fact that Moscow is justifying the price hike by saying that the Ukrainian rebate was compensation for the use of Sevastopol, and now that Sevastopol is Russian territory they no longer need to grant it. Wait ... what?
Here is the transcript of a meeting between Russian Prime Minister Dmitry Medvedev and Alexey Miller, the chair of Gazprom’s Management Committee Chairman Alexey Miller.
Dmitry Medvedev: What is the situation with Ukraine? Do we have any new issues or everything stands where it was?
Alexey Miller: Ukraine hasn’t settled the gas debt of the last year and today the county's outstanding debt for current gas supplies is increasing. Gazprom hasn't received any payments for the gas supplied in January, and our Ukrainian partners informed us yesterday that they would not be able to pay in full for the gas supplied in February. At the end of the last year it was agreed that Gazprom would give Ukraine a discount price for gas, provided that Ukraine would ultimately clear the debts accumulated over the last year and would pay in full for current gas supplies. Unfortunately, I have to state that Ukraine hasn't paid off for the gas supplied last year.
Dmitry Medvedev: How much in total have they managed to repay?
Alexey Miller: Speaking of the last year’s indebtedness, they have repaid USD 1.300 billion.
Dmitry Medvedev: Which means 50 per cent of the debt?
Alexey Miller: A little less than 50 per cent. The total gas indebtedness of Ukraine makes up USD 1.529 billion now. Given that Ukraine is not fulfilling its obligations or complying with the agreements reached when signing the contractual addendum providing a gas discount, Gazprom resolved to remove the discount starting from this April.
Dmitry Medvedev: I see. The one who fails to pay for the supplied goods should be aware that it is fraught with adverse consequences, including those related to the revocation of previously reached agreements on beneficial terms of supplies. Nevertheless, what is your opinion of the measures that should be taken to have this debt repaid?
Alexey Miller: Of course, the amount of Ukraine’s debt to Gazprom is considerable. The last year’s debt was reflected in Gazprom's budget for this year, and this amount is included into our investment program. Indeed, it is a big sum of money. Therefore, the easiest and efficient way for Gazprom would be to provide Ukraine with a loan in the amount of USD 2 or 3 billion so that it could settle its indebtedness accrued from the last year and pay for current gas supplies.
Dmitry Medvedev: It's no secret that those 50 per cent they paid came from the sovereign loan we had given them. Of course, this is a possible way of resolving this problem. I will entrust the Ministry of Finance to consider all the current possibilities and obstacles as well as all the contradictions related to the extremely low credit rating of Ukraine now, in addition to other aspects of the Russian-Ukrainian cooperation in this area. Firstly, Gazprom anyway should insist on the full coverage of the debt owed by the Ukrainian partner. Secondly, your decision to terminate the beneficial terms of supplies looks completely justified.
The gas price increase will be a hit. Ukraine was paying $7.60 per MMBTU under a deal negotiated in December 2013, down from $11.33 and compared to a price for delivery to Germany of $10.83.
Of course, it was the previous government what refused to pay off its debt. You know, the one under the Russian-backed president.
Problem is, the damage to Ukraine likely won’t end there. Gazprom could sue for its arrears under the Ukraine-Russia BIT. That could be a complete disaster for Ukraine; it could lead to all new funds being attached to pay off the Russians for their gas.
In fact, it gets worse. Russia loaned Ukraine $3 billion in the run-up to the crisis. Russia could transfer those bonds to private owners ... at which point the new bondholders could sue Ukraine!
In theory, the U.K. could stop that from happening since the bonds were issued under English law. Anna Gelpern suggests that the British parliament should move now to remove the enforceability of those contracts. That would be a good idea! But I don’t think it will effect the Gazprom debt. And Felix Salmon thinks that the Russians could trigger cross-default provisions in other Ukrainian bond issues. Boom boom boom and a legal nightmare for a Ukrainian government desperately in need of foreign financing to keep its economy afloat.
In short, it will be real mess for the Ukrainians, on top of all its other problems. Unless, of course, Kiev uses Western money to repay the Russians. For money advanced by them to the previous puppet government.
And as far as I know, there really is nothing that can be done via courts against the Russian Federation, despite crossing a border and forcibly annexing a region of a neighboring state.
The new legal international property rights infrastructure that we have built is pretty impressive. But man, sometimes it has perverse results.
Maybe I should not have recommended the essay on democracy. I read it while playing with my boy. I am re-reading it now. And it has this:
“Plato’s great worry about democracy, that citizens would ‘live from day to day, indulging the pleasure of the moment,’ has proved prescient. Democratic governments got into the habit of running big structural deficits as a matter of course, borrowing to give voters what they wanted in the short term, while neglecting long-term investment. France and Italy have not balanced their budgets for more than 30 years. The financial crisis starkly exposed the unsustainability of such debt-financed democracy.”
WTF? No no no no no it has not! Both countries have entirely sustainable debt loads. Even given that they have abandoned their own currencies they have sustainable debt loads.
What in the name of God is the author talking about? The essay is a weird mash. Lots of good points, some subtle, with the occasional bizarroland statement that reads like it was tossed out there to make sure the Tories (and Republicans) keep reading.
By the way, Alex Harrowell, we still need you.
The Monkey Cage was an awesome group blog. It brought serious political science research into the mainstream. It was all good.
And then it became part of the Washington Post.
Which gets us to an odd series of posts that attempts to convince the reader that American political polarization ain’t so bad. We can start with a post entitled “Gridlock is bad. The alternative is worse,” by Morris Fiorina of Stanford. Great scholar, great work ... but the argument is strange.
First, it assumes that the political parties would behave as they currently do under a more parliamentary-like electoral system. That makes no sense. One overreach followed by electoral disaster and that would be the end of that.
Second, to make his case that the parties left unfettered would do crazy things he writes, “The 2012 Republican platform plank stated essentially: never, no exceptions. The Democratic platform plank stated the opposite: any time, for any reason.”
Hmm. The GOP platform wrote:
Not a platform that I would support! And I would agree that point (5) effectively bans all abortions. But I would, no? Read objectively, this is to the right of median public opinion, but it is not off the charts. Of course I believe that it’s folderol, given the enthusiastic anti-abortion and anti-contraception actions of GOP-controlled state legislatures. But it sure is a sign that the national party understands the dangers of getting too far out in front of public opinion.
And the Democrats? Even less:
And that’s all she wrote.
So where does Fiorina’s characterization of the party platforms come from? You got me. He is a great scholar with a great book on polarization. But this was not written as a serious post. It has a slatepitchy feel: let’s devil’s advocate against the conventional wisdom. That has a place, I have been known to do it myself ... but it belongs not on the Monkey Cage that I used to love.
A worse post is Rob Ford’s “In America, polarization is a problem. In Britain, it could be a solution.” (This is the Rob Ford of the University of Manchester, not the other guy.) I have much to say about this, but I would rather make a public call for Alex Harrowell to come over here and fisk it for us. I will say simply that even if Ford is correct (Alex, we need you!), then I am not convinced that you have a problem if the only by-products are falling voter turnout and the rise of a rather silly buy aggressively anti-racist bunch of twits.
Now, as befits that great nation, the Canadian entry into the series is sober and serious. Richard Johnson of UBC limits himself to pointing out something that non-Canadians may not have realized: Canadian parties have become more polarized, whereas Canadian voters have not. That is the Monkey Cage I used to love: rigorously confirming the conventional wisdom (as AFAIK the above is the conventional wisdom in Canada) is a worthwhile initiative, Canadian or otherwise.
Anyway, earlier posts in the series are not slatepitchy, and some in fact argue against the American and British arguments mentioned above. And I do not want anyone to take this as a criticism of Fiorina or Ford. Like I said, I have done the same thing. And many counterintuitive pitches are indeed correct. But these two are odd.
So it isn’t likely to happen.
And now it is less likely to happen with E.U. Commission President José Manuel Barroso saying what we all knew already, which is that an independent Scotland would have to apply for E.U. membership, just like Iceland or Norway. The negotiations will not be easy, even through Madrid will likely agree to allow the application.
I am opposed to Scottish (or Catalan or Texan or Québécois or Regiomontano or Camba or whatever) independence because I am opposed in-general to secession from democratic states. First, secessionism generally requires a cramped nationalism that is too close to tribalism for comfort. Second, it smacks of democratic failure: you don’t like national policies, but instead of trying to build a majority to change them you pack up your marbles and leave. Finally, it is (albeit probably not the Scottish case) selfish, a way for richer people to dissolve their historic bonds of community with poorer ones.
I read the Crooked Timber thread. The positive arguments for smaller states boiled down to (1) We do not like the way that the U.K. votes as a whole, so screw it; or (2) nationalism, just because. (By that definition, I should be a huge proponent for the Republic of New York and New Jersey Only with the Annoying Bit of New York Removed and Maybe Horse Country Too.)
If there are unreconciliable historical wrongs in play, then I could be persuaded to support the partition of a notionally-democratic state. For concrete examples, see Ireland circa 1922, Algeria circa 1961, or Kosovo circa 2008. But those are extraordinary cases that involved a horrible combination of long-standing ethnic discrimination and very recent bloodshed. Moreover, electoral democracy in the modern sense was a recent arrival to all three mother states: the U.K. in 1918, France in 1958, and Serbia in 2000.*
Absent that, however, I say no. Secession should be off the table.
But I might be wrong to say no! Counterarguments very welcome.
* The Fourth Reform Act of 1918 introduced more-or-less universal suffrage to the U.K., although female suffrage remained limited until 1928. The French Constitution of 1958 granted full voting rights to all Muslim residents of the Algerian departments. Slobodan Milošević fell in 2000, after which Serbia (which remained notionally united with Montenegro until 2006) has held basically free elections.
Three recommendations. First, for those of you with a casual interest in the topic, there is a very brief review paper by Joseph Ferrie (Northwestern) and Timothy Hatton (Essex) on the last two centuries of international migration. (The paper actually covers the last four centuries, although it moves quickly over the 17th and 18th centuries.)
Second, Paul Collier’s new book, Exodus. It is a very well-written and thought-provoking brief in favor of immigration restrictions. If you click the link, it will take you to multiple reviews of the book. Most of the negative ones are tendentious and a little strange. This fellow here argues that countries should abandon all income redistribution in order to facilitate open borders. In that, he concedes Collier’s main argument, which is precisely that unlimited immigration could destroy the national sentiments that underpin liberal democracies. (Collier has a fascinating discussion of the theoretical circumstances under which this might happen; it is not a blanket argument. A blanket argument would obviously be stupid.) Nathan Smith at Open Borders starts by conceding Collier’s main point and calling for countries to impose special taxes on migrants instead of preventing their entry. (As an American, I recoil at that idea: differential taxation based on birthplace is contrary to the 14th Amendment. It is an odd suggestion for a proponent of open borders.) He follows up by saying that democracy is bad as part of an attack on Why Nations Fail, by Jim Robinson and Daron Acemoglu.To be fair, I am not sure that he realizes that he is arguing that democracy is bad. (I should mention that Jim Robinson is a friend.) Kenan Malik argues against a caricature of the book. One of the best parts about Exodus is how Collier lays down the conditions under which a diaspora will grow indefinitely and those under which it will not. Malik, however, writes, “A key argument in Exodus is that the levels both of migration and of problems created by it are linked to the size of diasporas.” Well, sometimes! But not always. I was left unclear what troubled Malik, other than that Collier is wrong about Great Britain. (Not being British, I can’t say, although Collier explicitly gives large shout-outs to the U.S. and Canada for our ability to assimilate immigrants.)
Finally, here is an incredible bit of investigative reporting into a Nigerian human trafficking ring. It is horrifying ... and quite amazing how the reporters made their escape.
Currency unions are a hot topic, for obvious reasons. The Eurozone has gone spectacularly off the rails. There is some evidence that currency unions boost trade (see Andy Rose here and here and this post) but considering the rolling disaster that is southern Europe many would consider that a small gain.
Therefore, a recent paper from Andy Rose has attracted a lot of interest: he finds that currency regimes have no systematic effect on macroeconomic performance. That is quite a find! It implies that the southern European countries would have been in trouble anyway. I found it via Tyler Cowen, who led me to comments by Paul Krugman and Antonio Fatas.
Except there is one thing about the paper. Page 3: “I exclude from the sample the five systematically important economies of China, the Eurozone, Japan, the UK, and the USA.”
Neither Krugman, Cowen, nor Fatas mentioned that the Eurozone countries are not in the data set; perhaps it is too obvious? It is still a great paper. And Tyler Cowen provides a solid explanation of the results.
But I am not sure that it tells us anything about the effect of the euro.
A Chinese company wants to build the world’s tallest skyscraper. As a result, there has been a lot of discussion about the “skyscraper index.” Does the groundbreaking on Sky City mean that the Chinese economy is about collapse? Is the world economy at risk?
Maybe. It could. I am on-record as a medium-term China bear. But that is really not what Sky City means. No, the real meaning of Sky City is the same as the meaning of the locks on the Panama Canal expansion: China’s manufacturing model has reached its limits.
What do the Panama Canal expansion locks have to do with Chinese manufacturing. Well, below you can see a video of the Panama locks being loaded onto the ships that will take them to Panama; they should arrive next month.
You got it: the locks are being built in Italy. Not China. In fact, very little of the equipment for the expansion is coming from China. Engineers on the project told me that Chinese work was cheaper, but they judged it too shoddy and unreliable.
And ... the developers of the Sky City project refuse to use Chinese steel because it is not safe. They will get the steel from Luxembourg instead. (I bet few readers knew that Luxembourg is a historic center of steel production.)
The upshot is that something is broken at the heart of China’s manufacturing model, at least as it concerns high-performance large-scale capital goods. If nothing else, Sky City exemplifies that concern.
The news from Europe today concerns the birth of the new British royal heir. I actually don’t think the news is that big: the only place my wife and I have heard it discussed is on television. That’s it. None of the nurses in her hospital have mentioned it. None of the cops I meet in the morning could care less. Ditto the gym, the coffeehouse, the sports bar. Zero zip nada except for Chris Matthews.
More important political news from Italy has been obscured. It seems as though the current Italian government wants to neuter the Senate.
The official position of this blog is that Senates are a bad thing. Of the ones reviewed here, the U.S. and the Philippines have the worst; Argentina’s and Brazil’s are pretty bad; Canada’s is redeemed only by its relative lack of authority. Only Mexico and Colombia have halfway-decent upper houses, and even those are still halfway-indecent.
On paper, the Italian senate is not terrible. Each region gets a number of seats proportional to its population. The coalition with the most votes (even if not a majority) in the region then gets 55% of the seats from that region. Bizarrely, the national voting age is 18, but for the Senate it is 25.
But in practice, it’s a problem. In the lower house the coalition with a plurality of votes automatically gets at least 55% of the seats. The government therefore has an automatic majority. (In most parliamentary systems the government usually gets a majority, although not always. Minority governments are generally considered a problem and usually short-lived.) In the Senate, however, the government is not guaranteed a majority. Unless a coalition can be cobbled together, you run the risk of having the government collapse. Moreover, even when a government is formed, bicameralism slows down decision-making.
So now the current Italian government is trying to neuter the upper house! I approve. How can they do that, might one ask? Well, simply, if the Senators believe that replacing the Senate with a weaker body is in the interest of their party, then they will vote for the reform.
Nonetheless, success is unlikely ... but it sure beats the way the Canadian government wants to strengthen its Senate.
It is a bit of a truism that property rights are key to economic development. An efficient system, runs the logic, needs to be transparent, transferable, excludable, and enforceable. In a bit more detail:
Without those characteristics, runs the logic, you get underinvestment and confusion and commons-tragedies and all that. And the logic has some empirical backing. For example, in 1986 the Buenos Aires provincial government offered a group of landowners compensation for land that had been seized by a group of squatters. Some landowners took the offer, and the province then transferred title to the squatters. Others did not. On the assumption that the squatters had no way to know whether the landowner from whom they had seized the land would take the provincial offer, Sebastian Galiani and Ernesto Schargrodsky found that the squatters who received titles invested more in their homes and the education of their children.
Here comes the New York Times with an article about terrible land titles in Greece:
“In this age of satellite imagery, digital records and the instantaneous exchange of information, most of Greece’s land transaction records are still handwritten in ledgers, logged in by last names. No lot numbers. No clarity on boundaries or zoning. No obvious way to tell whether two people, or 10, have registered ownership of the same property.”
The article goes on to say that even the former Yugoslav states have better land rights.
One reasonable conclusion would be that bad property rights are a drag on economic recovery. “Many experts cite the lack of a proper land registry as one of the biggest impediments to progress. It scares off foreign investors; makes it hard for the state to privatize its assets, as it has promised to do in exchange for bailout money; and makes it virtually impossible to collect property taxes.”
But another reasonable conclusion would be that the evidence about the importance of clear property rights is wrong ... or at least oversimplified.
There is no getting around that fact that Greece became a rich country despite terrible property rights. The above chart tracks GDP per worker in 2005 dollars (adjusted for purchasing power) for four countries from 1950 to 2011. (The data through 2010 is from the Penn World Tables 7.1; the 2011 data comes from the OECD.) In 1950, Greek workers produced as much as Colombian ones; they were significantly less productive than in Mexico. Over the next three decades, Greece far outdistanced its Latin American counterparts. The current depression has not eliminated that gap.
Greece, of course, had many advantages that Colombia and Mexico did not, but poor property rights did not stop the country from taking advantage of them.
It has to make you wonder. Despite the micro evidence from places like Argentina, are efficient property rights really as important as we think they are?
If I were the president of Cyprus, knowing the little that I know right now, I would take the country out of the Eurozone. But that is not a no-brainer. There would be a lot of losers. Cyprus should leave the euro, but it won’t, because the losers outweigh the winners in the short run.
Who would be the losers from leaving the euro?
OK, so who wins?
How will this political logic look by the 2018 election? Well, I’m pretty sure that it will look like staying in the euro was a bad decision. In that sense, I would advise President Anastasiades to leave the euro now and bet on re-election on the wave of a giant economic boom by the time the next presidential election rolls around.
The problem is that it is not at all clear that such a move will look great by the time of the next legislative election in 2016. There are a lot of short-term losers, and they are politically powerful.
In fact, given the opposition, a new currency may be impossible. The president of Cyprus is powerful, but he cannot unilaterally introduce a new currency. There would have to be wide support for such a move. The problem is that most of the soon-to-be-unemployed won’t give it, the bankers are unlikely to act in their self-interest (this is oddly true of American bankers, I should add), and those who owe debts to foreigners can only be appeased by radical changes in Cypriot bankruptcy law. (It is currently very strict; e.g., creditor-friendly.)
While leaving the euro looks like a clear decision at first glance — two-thirds of Cypriots support it! — the politics rapidly gets blurry by the second and third look. Argentina left the American monetary union after a punishing depression had reduced the economy to barter; Mexico’s president could unilaterally devalue (and pretty much had no other option by that point). Leaving the euro would almost certainly lead to a richer and stabler Cyprus by 2018 … but the above analysis, superficial as it is, makes me think that you can’t get there from here.
Cyprus will have a long and grinding depression, but it will not (unlike Argentina) be reduced to barter because the ECB will provide just enough liquidity to insure that does not happen. Things will get awful, but probably never quite awful enough to get the government to take the logical step. It’s a tragedy for the Cypriot people, but an entirely understandable one.
I while back I wagered that the euro would not make it to May of this year. I am now conceding defeat. Why? Not because the clock ran out. No, because Cyprus is staying in.
Back then, I worried that things would get so bad that a country would have no reason not to ditch the euro. If the banks closed, I argued, then the costs of switching would no longer apply. At that point no rational government that wanted to win re-election would stay in; everything would be upside.
Well, Cyprus has reached that point. The banks are closed, capital controls are imposed, the and the debt-GDP ratio is set to explode since the Germans insisted, insanely, that the E.U. bailout be channeled through the island’s government. So there is no worry about bank runs and no worries about driving banks to insolvency. And there should not be a worry about sovereign default: Cyprus is now going to have to default or raise taxes to truly eye-popping levels.
Yet the Cypriot government shows no sign of abandoning the single currency.
OK, then. Past performance does not predict future results: should Spain reach that point their government might behave differently. But it might not. I am given pause by the sight of Cyprus happily plunging right into a depression with no promise of aid from the rest of Europe and a very easy out right there.
And so, I proclaim error ... but stand astounded that European governments are willing to sacrifice their people to an E.U. that seems so unwilling to do anything in return.
Gavin Wright is one of the best economic historians of the United States. In a seminal article, he advanced two findings. First, early American industrial success was due to access to cheap abundant natural resources. Second, there was nothing special about America’s geological endowment that caused it to enjoy cheaper and more abundant natural resources. Rather, Americans were particularly innovative in figuring out ways to turn their geological endowments into usable economic resources. In a 1995 paper with Paul David, the authors cheekily called American resource abundance “socially constructed.”
American industrial dominance faded as the technologies developed in the United States spread to other places. (Lower transportation costs helped: cheap Australian iron could power Japanese industrial exports, for example.) Over time, some countries also developed the ability to indigenously develop new natural resources (an article by Wright and Jesse Czelusta mentions various South American nations, in addition to Australia, Canada and Norway) but it really was not until the second half of the 20th century.
History is repeating itself. The technologies allowing for the development of shale gas and tight oil have originated in the United States. (There has got to be a paper in why.) But there is nothing particularly special about America’s geology. There is likely a lot of shale gas in Europe, among other places.
The question is how fast can the technologies invented in the United States be deployed overseas? The Economist points out that even if you can get past the political barriers, it will still likely take a decade for exploration and development. I am not so sure that it has to take that long, but there is a very serious obstacle to developing European shale ... the flowback.
Basically, when you dig a shale well it produces a lot of wastewater: the flowback (e.g., the fluid that you pumped down there to fracture the rock) and other water liberated during the drilling. That water is nasty stuff, regardless of what you pumped down there in the first place. It contains heavy metals, icky long-chain hydrocarbons, and is slightly radioactive. (The link goes to a USGS report.) In most U.S. plays, you get about 600,000 gallons of flowback and other water in the first ten days. You then get another 200 to 1,000 gallons per thousand cubic feet (MCF) of natural gas. (An EPA study is here.)
So what do you do with the toxic and salty and mildly radioactive flowback? Well, in the United States we pump it into Class II disposal wells: lightly regulated abandoned old wells, mostly owned and run by small mom-and-pop operations. (And I do mean lightly regulated. Click the link and be horrified.) We truck the stuff thousands of miles (in an exercise with some of my students, we estimated a minimum flowback disposal cost of 25¢ per MCF) or recycle it for use in other fracks. Chesapeake, for example, reuses about 6% of its water and aims to up that to 20% in some plays. But that will still leave 80% of the sludgy briny glowing water to be dumped somewhere.
And most of Europe does not have a century of oil and gas drilling behind it. The U.S. has literally hundreds of thousands of Class II wells lying around. Britain and Poland do not. So where are they going to dump the wastewater?
I would go so far as to call this a dealbreaker for most European countries (Ukraine excepted) save for one caveat: there is a huge opportunity for companies that can invent ways to better reuse the flowback. The DOE has already put some (rather small) monies towards this purpose. But this is a place where the case for subsidies is weak. There are huge incentives for anyone who can figure out a way to substantially cut the amount of flowback from fracking to make a lot of money.
So I read in the New York Times that Greek private sector salaries fell a punishing 22.5% in 2011 in real terms. That stunned me. So I went to Eurostat. Their figures for nominal labor costs were slightly less impressive, but still shocking. (2008 = 100.)
Internal devaluation at work! Sure, Greece is still working off earlier excessive wage gains, but that should presage an export boom, right? Cheaper workers, cheaper vacations for foreigners, more tourism, more exports.
Except ... well, according to OECD data, output is declining along with wages. (See below; 2005 = 100.) Unit labor costs are down, but not when seasonally adjusted, and really not relative to Germany or the rest of the Eurozone. Maybe that’s not relevant. After all, as long as output per worker in potential export sectors isn’t falling, then economy-wide unit labor costs should not matter ... but only for those industries. They will matter a lot in other industries, which are seeing demand (foreign and domestic, as proxied by the value of output) drop as fast as their wage bill.
Add to that (1) rising debt burdens for Greek workers, since debts aren’t indexed to wages; (2) rising taxes on Greek workers; (3) people’s desire to save in euros (outside Greece or in cash) in the face of a possible Grexit; and (4) the awful awful feeling that comes with people as they watch their nominal incomes plummet.
Put it together, and it isn’t clear to me that the rather surprising unstickiness of Greek wages is going to produce much of a quick recovery even if wages fall substantially more. (There have been a lot of reforms to Greek labor law in the last few years.) Of course, the Argentine experience implies that a Grexit won’t be better ... Argentine GDP plunged 15% in the year after the devaluation, and recovery took place in the context of strong external demand.
I am not optimistic.
Hey, my blog is a nothing and that is how I like it. So it’s a good thing that Matt Yglesias is pointing out that if Spain suffers lots of capital flight (or otherwise sees its money supply collapse) then the worst effect of ditching the euro will already have happened and there won’t be many reasons to stay in.
Presumably the German government will now decide that the E.U. needs a unified system of banking regulation and deposit insurance plus some mutualization of existing debt, wedded to a stability pact and new labor legislation. Obvious!
What will happen? Well, Setty pointed out that we have seen this movie before. In general, I think he is correct ... with a wrinkle.
There is, however, a wrinkle. That wrinkle is that Argentina is the first country to try to stick it to ICSID. They have just said no. That has, shall we say, annoyed other countries. Consider that the Obama Administration has imposed sanctions on Argentina ... the first time that an American president has used the 1974 authority. The diplomatic reaction from Spain ... and Britain, and the European Union, and Mexico and Chile and (OMG!) Bolivia ... has been ferocious. This is looking much more like 1968 or 1938 than it is like more recent expropriation events.
It might play out quicker than we expect. The big if is the European Union. If it uses its muscle, regardless of legality, then Argentina is going to hurt. If it does not, then the Setty calendar will play itself out.
Either way, it will be a show.
I recommend the Sober Look blog. If you want something scary, go here. The short version is that the European Central Bank has completely lost control of the Greek money supply. It can print euros and buy loads of Greek assets, but all the liquidity drains right out of the country. Basically, nobody wants to hold deposits in Greece. On the flip side, nobody outside Greece wants to lend to a Greek company. In the words of a commentor, “The Greece analogy to a state in the U.S. no longer applies.”
A while ago, Doug Muir and I had a debate about Eurozone exit. We agreed that if the banking system collapsed and capital flight went out of control, then the costs of exit would no longer apply ... because the bad effects of exit would have already happened. The implication of a collapse in the Greek money supply is that absent more fiscal help from the rest of the Eurozone, there is no longer any reason for Greece to stay in.
Other than, of course, warm and charitable Greek feelings towards the rest of the Eurozone.
It appears that the German government has just announced that it wants Greece to renounce its sovereignty in return for more credit. (Well, at least in return for the release of existing credit lines.) The idea isnt new: in 2002, two prominent economists seriously proposed that Argentina give up its sovereignty for five years. Of course, Argentina has done quite well for nine years by breaking all the rules, but it is far from clear that Greece could copy that, or that Argentina will continue to do well.
There is a historic parallel: the U.S. and the Dominican Republic in 1905. (Actually the U.S. and lots of Latin American countries, ranging as far afield as Peru and Bolivia, plus Liberia ... but let’s wait on that.) Short takeaway: Washington was way more generous back in those benighted days, with very little at stake, than Berlin is being today, despite massive repercussions for Germany if things go wrong.
The backstory was about what you might expect. The D.R. had defaulted; its government was facing multiple armed revolts; and the Germans were nosing around. This latter made Washington nervous that a rebel force (or one of the rapidly-changing governments of the day) might transfer a naval base to Germany in return for aid. In fact, after U.S. intelligence captured a letter from General Demetrio Rodríguez openly requesting aid for President Carlos Morales, Captain James Miller “invited” Rodríguez on board his ship, where he explained: “Neither he [Morales] nor anyone must think for a moment that Germany or any other foreign power could be situated in any portion of the Dominican territory.”
President Morales saw an opportunity. If he could convince the United States to take over his country’s customhouses, using the German threat as motivation, then he could kill three birds with one stone. First, having U.S. troops in the ports would remove them as strategic targets for rebel forces. Second, U.S. officials could manage the customhouses far better than corrupt Dominicans, thereby increasing revenue. Third, if the Americans could be convinced to skim a bit off the top and use that to guarantee debt repayments, then the D.R.’s borrowing costs would go down, and Morales could borrow more on top of the increased revenue. Win win win! Who needs sovereignty? (Two out of the three points, one might think, would apply to Greece today.)
Uncharacteristically, President Theodore Roosevelt (in his own words) chose to “put off the action until the necessity became so clear that even the blindest can see it.” He was a bit worried that American public opinion might not be thrilled with the idea of involvement in somebody else’s civil war, not while the Philippine War had only just ended two year previously, and not with U.S. troops still fighting in Mindanao. So Roosevelt waited, and the Dominican situation got worse, and the Europeans kept nosing around, and American investors kept screaming, and finally in May 1904 the President proclaimed his famous corollary to the Monroe Doctrine. It read:
Any country whose people conduct themselves well can count upon our hearty friendship. If a nation shows that it knows how to act with reasonable efficiency and decency in social and political matters, if it keeps order and pays its obligations, it need fear no interference from the United States. Chronic wrongdoing, or an impotence which results in a general loosening of the ties of civilized society, may in America, as elsewhere, ultimately require intervention by some civilized nation, and in the Western Hemisphere the adherence of the United States to the Monroe Doctrine may force the United States, however reluctantly, in flagrant cases of such wrongdoing or impotence, to the exercise of an international police power.
Thing is, it still took a while to build support, and there was, you know, an election to win. President Roosevelt didn’t agree to Morales’s request until December 1904, a month after the U.S. presidential vote. The Senate, it turns out, had other ideas. Roosevelt decided that with the election past, that wasn’t a problem, and so the U.S. took over the customhours without a treaty on March 31, 1905.
Under the agreement, the U.S. directed 55% of customs revenue towards debt payments, but it did not do so mindlessly or automatically. Rather, it banked the money until February 1907, when it finally forced the D.R.’s creditors to accept a 50% haircut on their outstanding principal. (The average coupon was reduced to 5%.) In fact, if expropriation claims are excluded, creditors accepted a 57% haircut on their debt.
Moreover, the agreement worked: there was no austerity. Even after the U.S. took 55% off the top, government spending did not fall. Moreover, the D.R. managed to go to the capital markets as early as May 1907, when it refinanced its outstanding post-haircut debt of $15.8 million and borrowed an additional $3.9 million. ($3.9 million is, as a share of U.S. GDP, the equivalent of $1.7 billion in 2010.)
And therein lies the rub. Or rubs. First, the D.R. was not a democracy in 1904; Greece is one in 2012. Second, the D.R. asked for the receivership; the Greek government is not. Third, the U.S. used its good offices to obtain a very favorable debt restructuring; the E.U. (meaning the Germans, really) is letting Greece hash things out with its creditors on its own. Finally, in the case of the D.R. the U.S. really was able to improve custom collection; I’m not sure that anyone believes that a foreign administrator will be able to easily improve the Greek internal revenue service inside a culture of widespread evasion.
In other words, the U.S. was much more generous to its dirt-poor neighboring nondemocracy than the Germans are being towards their not-as-poor fellow democracy. Good luck with that. Unless, of course, failure is the plan.
For various mostly-professional reasons, I have been thinking about war lately. (References: Winning the War on War and Where Have All the Soldiers Gone?) In an earlier discussions Jussi Jalonen argued that war will not disappear, but I was not convinced.
“Unthinkable” is an overused term. It’s usually used to mean “awfully bad, and to be avoided.” Or, more accurately, “Too unlikely or undesirable to be considered a possibility.” That meaning, obviously, is hyperbole.
But there is a second meaning: impossible to imagine occurring in reality. That is a very concrete meaning. One can imagine all sorts of impossible things, but an unthinkable one is something that slips from your grasp when you sit down and try to think about how it might come about.
There are a lot of incredibly improbable things that are not unthinkable on a 50-year scale. Since this great debate attempt is about war, let’s give an example: a civil war in the United States. That is incredibly bloody unlikely even in a 50-year scale, I’d bet large sums against it, I’ll argue strongly that it won’t happen ... but one can imagine plausible scenarios. It reaches the first level of unthinkability (too improbable to be worth seriously considering) but not the second.
Proposition: interstate war in Western Europe has reached the second level of unthinkability. There is no set of imaginable circumstances that will lead a western European government to decide that it needs to kill citizens of another European government in an organized fashion.
The Kingdom of the Netherlands is a strange animal. It isn’t much of an empire. Nor is it a proper federation; it doesn’t even have a federal government per se. International treaties apply differently to the different parts. (See Articles 24-28 of the Charter of the Kingdom.) The Caribbean members have duty-free access to the European Union, but there is no true common market. In theory, Article 35 requires that they pay for their own defense. (In reality, it doesn’t matter: the insular Caribbean outside Cuba is a de facto military protectorate of the United States.) The Supreme Court of the Netherlands is the ultimate court of appeal, but most of the ex-British insular states (save Barbados and Guyana, but including Mauritius an ocean away) still use the Privy Council. It uses a different currency, with its own central bank. Finally, the Caribbean countries can all withdraw fairly easily, using provisions laid down in the Charter. Sint-Maarten could remove Dutch influence far more easily than the Bahamas could get rid of the United States.
So is the Kingdom meaningless? Are the constituent countries simply independent countries without a seat in the U.N.? Well, not quite. First, there is a common citizenship. Immigration and naturalization laws may vary (the latter by rather little), but once you’ve got that Kingdom passport you’re a full citizen. If Great Britain had been willing to extend that to the West Indies Associated States, I doubt that any of them would be sovereign countries today. (To be fair, the WIAS had other issues, not least of which that there was no equivalent of the Charter. British officials treated the association as nothing more than a British administrative inconvenience, which rankled on the islands.)
Second, law enforcement. The relationship is a bit of a mess. This Dutch document goes into it: since I am not a Dutch speaker, and translation software is overvalued, I can’t say that I understand the details. That said, while Dutch police have less authority in Sint-Maarten than, say, the FBI does in Puerto Rico, they do have authority, even if they generally need local approval to make arrests. That is a bit more authority than, say, OPBAT gives American officials in the Bahamas, or than DEA agents have in Colombia or Mexico.
Third ... well, here it gets interesting. The Netherlands provides financial support to the other countries in the Kingdom, but it is phasing it out. Development and fiscal aid is supposed to end by 2013. In fact, transfers have been generally miniscule. According to IMF data, in 2008 aid to Sint Maarten amounted to only 0.3% of GDP.
Recently, however, that has changed. Aid rose to 2.0% of GDP in 2009 and 6.2% in 2010, most of it to pay off Sint-Maarten’s debt arrears. More substantively, the Netherlands took over the debt from the former government of the Netherlands Antilles that otherwise would have gone to Sint-Maarten, a gift worth approximately 30% of the country’s GDP. In return, however, the island has had to accept Dutch financial supervision. The Financial Supervision Authority is supposed to stick around until 2013, by which point Sint-Maarten is supposed to have trained up enough people to take over the functions formally carried out by the government of the Netherlands Antilles. We’ll see.
In short, being part of the Kingdom of the Netherlands is a bit more substantive than simply lacking a U.N. seat. That said, technical sovereignty matters very little. The U.S. routinely took control of the finances of Latin American countries before WW2, and the IMF effectively does so today. (A country can refuse IMF money, of course ... but Sint-Maarten can, in theory, also refuse Dutch support.) Similarly, law enforcement officials from a powerful state can often find ways to exercise their authority inside a weaker one. Finally, lots of nominally sovereign countries share or outsource judicial authorities. What matters, rather, is citizenship and the moral authority to call on Dutch resources when necessary. It is a relatively weak relationship, but a real one nonetheless.
The French side of the island is completely different. If there’s interest, I’ll discuss it later.
The basic problem confronting the eurozone right now is that the European Central Bank refuses to act as a lender of last resort. Outside Greece, most of the other countries are perfectly healthy as long as interest rates don’t rise too high. (Consider Portugal.) Of course, that’s the rub. As interest rates rise, debt levels start to look less sustainable. As debt levels start to look less sustainable, people sell their holdings of the debt. As people sell their holdings, interest rates rise. As interest rates rise, rinse and repeat.
Normally, a central bank would come in and calm things down by promising to purchase new debt at a reasonable interest rate. This is why Britain and the United States have had no problems; everyone knows that their central banks stand ready. Eurozone countries, however, don’t have their own central banks. That makes them vulnerable to self-fulfilling panics.
And here’s the second rub: Germany also lacks a central bank! So why should Germany be immune? To some extent, the country is protected by the fact that it’s the safe haven: when people sell other countries’ bonds, they buy German ones. But that’s only partial. Speculation has hit countries as healthy as Germany, like Austria and Finland. Considering as there still are other places to park your money (U-S-A! U-S-A!), and the European Central Bank is still doing its level best to start a second Great Depression, then there is no reason why German bonds should be invulnerable to the panic.
And lo! Germany just had a failed bond auction. Yields rose from 1.98% to 2.07%, far from a disaster, but not a good thing in economic terms. In fact, it is worse than you think. So what’s the silver lining?
Simply that if Germany starts to be affected, then Angela Merkel will stop being evil.
I should add here that other analysts think that Germany’s pain threshold is far higher than a blip in yields or the collapse of the eurozone’s repo market. “In other words, the time to sell bunds will be when Germany finally realises the game is up and reluctantly props up the Eurozone, probably via the printing presses of the ECB. Unfortunately, that won’t happen until Eurozone has a near death experience with countries threatening to leave the currency union and customers lining up outside banks demanding their money back.”
If that’s right, and it probably is, then we’re in trouble. But I’ll still say that on the margin we’re at least a millimeter closer to sanity than we were yesterday.
In an earlier post, I discussed the strategic nuclear balance on the eve of the Cuban Missile Crisis. The chief takeaway was that the Soviet Union possessed very little ability to threaten the United States in 1962. President John Kennedy was a hero not because he saved the United States, but because he took seriously the lives of the Russians and Europeans who would perish.
Here I want to draw attention to how lucky the world really was. A nuclear war that “spared” the United States (at least outside the southeastern cities within range of Cuba-based rockets) would nonetheless have been a horrifying event without parallel. Below is a BBC documentary from 1965 that gives a horrifyingly unvarnished view of what such a war (even had it occurred in 1962) would have entailed.
The movie has other virtues. The preacher around minute 27 explains why I strongly believe that conscription is a moral imperative for anyone who is not a pacifist. And it puts our modern fears in perspective. It is worth watching. (Credit to Charlie Stross.)
Over the last two months, family business has kept me away from blogging. Before that, I was in the throes of finishing a first draft of a book manuscript. The family business is over and I’m now in the far more relaxed process of fixing the manuscript, so this time I think I think we’re really back!
In December of 2010, I made a bet with Doug Muir and Omar Serrano that the eurozone wouldn’t make it to March 25th, 2013. If any of the big eurozone economies leave the single currency, I win. The bet is structured so that I will lose even if Ireland, Portugal, and Greece all abandon the euro; it has to be Spain or Italy. The loser will either fly across the Atlantic to meet the winner, or pay for the winner to fly to meet them, and then buy them a steak dinner, with port and cigars.
The big question, of course, is how a government could leave the eurozone. Now, Nick Rowe has proposed a way. “Eurozone governments and banks that cannot pay their obligations in euros may end up paying their obligations in a scrip that is not pegged to the euro. A scrip issued by each national government that is worth whatever people think it is worth. And if people start using that scrip as a medium of exchange, and medium of account, it becomes a new money. Sure, Greek supermarkets might prefer payment in euros, but if their customers can only pay in New Drachmas, then it’s either accept New Drachmas or let the vegetables rot on the shelves. And the supermarkets’ suppliers might prefer payment in euros, but it’s either accept New Drachmas or let the vegetables rot in the fields. And the workers picking the vegetables might prefer payment in euros, but it’s either accept New Drachmas or nothing.”
Sounds almost painless! Matt Yglesias implied so. But it wouldn’t be! It would be a mess and cause the economy to cycle the drain until the government defaulted on its debts anyway. Moreover, it would not cause the scrip to drive euros out of circulation.
Consider, for a moment, what Spanish obligations consist of. In part, they are debt payments. Spain’s debts, however, are denominated in euros and will remain denominated in euros no matter how many nuevas pesetas are printed unless the Spanish government withdraws altogether from the European Union. Rather, the obligations which the Spanish government can insist on paying in nuevas pesetas are the obligations that it owes to its own citizenry: salaries, pensions, unemployment benefits, etcetera. The nueva peseta would trade at a discount against the euro, of course, but that is the idea.
Except ... the incomes of Spaniards would drop in terms of euros. They would be increasingly earning in discounted nuevas pesetas. The problem, of course, is that they would then be paying less taxes in terms of euros. But the Spanish government owes debts denominated in euros! The debt burden would rise. The more the debt burden rises, the more the government needs euros to pay it. The government would, of course, trade nuevas pesetas for those euros. That would increase the discount on nuevas pesetas, further driving up the size of the debt burden, further increasing the discount on nuevas pesetas. (While this is going on, the interest rate on Spain’s euro debt would skyrocket, of course, unless it is by then owed to the European Union rather than private investors. In that case, however, it is very unlikely that Spain would be going around issuing scrip to pay salaries.) At the end of the story Spain’s income in euros falls enough to force the government to default on its euro debts, but only after setting off an inflationary spiral.
There’s a second problem. Rowe wrote, “Greek supermarkets might prefer payment in euros, but if their customers can only pay in New Drachmas, then it’s either accept New Drachmas or let the vegetables rot on the shelves.” That, however, isn’t correct. Government employees might be paid in new drachma, or nuevas pesetas, but they can exchange those pesetas for euros. The supermarket cannot be required to accept those pesetas unless Spain leaves the eurozone. If the owner insists on being paid in euros, then the customers will swap their pesetas for euros in the market and he or she will be paid in euros. This is a process that has occurred in many high-inflation countries, where people abandoned the local currency for the dollar ... and in most of those countries, the dollar was not legal tender! In short, the logic breaks down at that point: it is not clear why the pesetas would replace the euro as a medium of exchange ... except, of course, to make tax payments.
Of course, it isn’t clear that Spanish government employees (or pensioners, or students, or the unemployed) would want to receive devalued nuevas pesetas in lieu of euros. They would, quite rationally, perceive it as a pay cut. Anyone who owed money would be doubly hit: their debts would still denominated in euros.
Finally, such an action would be perceived (correctly) as a prelude to formally leaving the eurozone, precipitating the mother of all capital flight. Without leaving the eurozone (in fact the country would have to leave the European Union altogether) the government would have no way of combating that flight.
In short, introducing scrip would be a terrible way to exit the eurozone. It would run a high risk of triggering a depression, and it would certainly worsen the country’s debt burden. Professor Rowe is, I think, incorrect. History bears this out: the issuance of patacones (or créditos) in Argentina around 2000 did not result in the creation of a new Argentine currency or stave off default. Rather, they contributed to the depression, and quickly inflated away.
There are many ways in which the eurozone could fail. The issuance of a parallel currency for any length of time strikes me as one of the worse ones. Is there a hole in my logic?
Anglo-French forces have begun making helicopter strikes from carriers in support of rebel operations. They join the Anglo-French air sorties (which now outnumber U.S. sorties by a growing margin) and the Anglo-French ships that have been shelling shore targets in support of the rebels in Misurata. (War nerds should click the second link.) William Hague, meanwhile, was in Benghazi two days ago.
It is an excellent level of support. (Everyone should read this comment by Doug Muir, and this post by Alex Harrowell, at which point somebody should answer the queries they raise.) But four days ago one country put them all to shame, a most unexpected country: Italy. Yes, Italy. Home of the oil company that seriously thought it could reclaim its oil from Gaddafi. Home of one of the Colonel’s biggest friends. Land of the supremely bizarre “Friendship Treaty” between the Italian Republic and the Grand Arab Libyan Popular Socialist Jamahiriya. Italy!
Ever since Gaddafi demonstrated that he could hit rebel oil production, the rebel government has been hard up for cash. (The one tanker that they got out has finally been purchased by a refinery in Hawaii.) Legal confusion in the United States has held up the rebels’ ability to access Gaddafi’s assets, or use them as collateral for loans. (The recent sale of rebel oil to Hawaii is an indication that this fog may be lifting.) So how is the rebel government going to get the foreign exchange that it needs?
Enter Italy. Foreign Minister Franco Frattini, said Rome would, through Eni and UniCredit SpA, “provide the [rebel] council for the needs of the Libyan people with a huge quantity of fuel and a huge amount of money.” He added: “We are talking about billions of euros that is not money of the regime. This is money of the people of Libya. [These] important frozen assets can represent a very valid guarantee for this transfer of money to the Libyan people.”
In the absence of NATO forces capable of hitting irregular government troops far inland, then the only way to get resources to the rebels is to let them borrow against government assets. British training is all well and good, but the rebels need air support, and right now they do not have it outside a narrow coastal band. So ... Italy just won huge credit by offering cash. Stratfor likes to insist that the Anglo-French effort is all about securing petroleum contracts at Italian expense: if so, Rome just blew a hole in that idea. The rebels should look at Eni et al pretty favorably ... and the decision to channel the lending through Eni only reinforces that.
On the other hand, Britain seems to be training the rebels on the ground. Serious rebel training would obviate the worries about the oil fields, by allowing the rebels to coordinate with foreign air forces operating at high altitudes. (To be frank, getting the rebels into some sort of recognizeable — and hard to copy — uniform would help.) That will also be quite thanked.
In short, the postwar question will be: does concrete Italian financial support outweigh concrete Anglo-French military support? I suspect that given the legal mess, the former will prevail. But then again, I never did believe the idea that Cameron’s and Sarkozy’s decisions had been driven by a desire to have their national companies (particularly BP) seize formerly-Italian production contracts. That said, Rome seems to have found an easy (and almost costless) way to insure that its interests will survive the conflict.
It would be nice if the U.S. would move as quickly in unfreezing Libyan assets. It was a heroic effect to clear the Hawaiians to import rebel crude, but there is more to do. Britain and France, it is time to start serious lawfare.
There have several important developments in the Libyan civil war, not least the temporary incursion into Tunisia and NATO’s decision to begin attacking Libyan state institutions. (The death of one of Gaddafi’s sons is a result.) These are important, but developments regarding the country’s oil industry are even more so. And so, this update.
Last weekend, government forces damanged rebel-controlled oil fields. How is not certain. Tripoli claims that British warplanes did the damage, but that seems unlikely to say the least. Wahid Bughaigis, the rebel oil minister, said that the damaged equipment included a generator, an oil tank, and several small diesel tanks to fuel the generators. The rebels say they will need at least a month to repair the damage.
The problem is that the rebels do not control the refineries or gasfields. They therefore need to import fuel, and that’s expensive. The Qatari government (working with Vitol, an oil trader) helped the rebels market one million barrels (for an above-market $129 million in revenue). The MT Equator tanker, carrying 550,000 barrels of that oil, arrived in Singapore for refueling on April 28, before steaming on to China. (China is being quite helpful where it counts.) $129 million, however, is not a lot in terms of rebel needs. Bougaighis said: “To put things in perspective, one cargo of gasoline of 25,000 metric tons costs us $75 million, so you don’t go far with $129 million.”
I suspect that he is wrong about that: 25,000 metric tons is around 7.9 million gallons, and I doubt they’re paying $9.44 per gallon. But I am sure that the rebels are facing energy problems. Benghazi used to get its electricity from natural gas supplied out of Brega. Brega, however, is in government hands. As a result, the rebels have cut electricity production in Benghazi by 25 percent to conserve fuel. Of course, in a country without anything resembling a smart grid, electricity cuts mean rotating outtages running as long as 3½ hours. Bughaigis: “We didn’t have this problem when the gas was supplied to the plants, but now we have to supply it (diesel) by sea and get it from the road.”
For what it’s worth, the U.S. cleared up (as best as it could) the remaining uncertainty about the ability of Americans to buy Libyan oil. The Office of Foreign Assets Control (OFAC) declared that said transactions involving Qatar Petroleum or Vitol are permitted provided the entity in Libya is under the control of the rebel-backed leadership. Anyone dealing with Libyan oil purchases must supply a report to OFAC detailing the arrangements within 30 days. The practical significance of this is limited, however, since the Europeans opened the door to rebel oil sales some time ago.
In the Department of Obvious: Vienna-based OMV, which produces some 10% of its total oil and gas production from Libya (33,000 boe a day), is seeing its profits go down. Production at the Shateira oil field shut down at the end of February due to violent clashes between government and rebel forces. Libya provided 20 percent of the crude used by OMV refineries, but it has been able to buy crude from Saudi Arabia, Kazakhstan and the Black Sea region to make up for the slack. OMV will have to upgrade the refinery in Burghausen, Germany, to process non-Libyan crude, but it should be able to do that.
Department of Not so Obvious: Eni’s production is down 9%, but profits are up 15% on high prices. Since April, Eni production in Libya has been about 50,000 to 55,000 barrels of oil equivalent per day, down from 280,000. (Libya accounted for about 10 percent of Eni's overall cash flow.) Eni said since April the company has been producing 50,000 to 55,000 barrels of oil equivalent a day in Libya for local electricity production, all coming from its Wafa facility. No Eni facilities in Libya have been damaged and are currently on “hot standby” ready to produce again once the situation stabilizes.
And finally, Department of WTF: Eni appears to have sent a tanker to western Libya to try to pick up oil from its production facilities. The Aqua got within a few kilometres of the Libyan port of Mellitah before turning away between April 20 and 21. (The booking from Mellitah to Venice probably cost over $500,000, including a risk premium to venture into Libyan waters.) It was there to load up 600,000 barrels of oil. The Libyan government, obviously, refused to let the Eni ship fill up. “They didn't want the crude to go, because they wouldn't have gotten any money for it,” said an industry source, adding, “They could use it to refine into gasoline.” I can understand why NATO would be happy to let the Italians give it the old college try (“Go get your oil! Just make sure that Tripoli knows it won’t get any money for it, 90% tax rate be damned.”) I am less sure as to why Eni thought it could possibly get its oil.
So there you have it. Nothing here changes the assessment that the rebels will win, but the government ability to strike at the fields is unexpected.
Libya update: So far, both Doug Muir and I appear to be correct. The war has devolved into a stalemate, but casualties are only racking up in Misrata, where the New York Times estimates between 313 and 1,000 deaths thus far. That is a tragedy, but far less than it could have been.
Calls to send ground forces are growing, but the United States so far shows no signs of seeing any political pressures, domestic or foreign, to send American troops. The E.U. has signed off on a 61-page “concept of operations” to send roughly 1,000 troops to coordinate humanitarian relief, most likely in Misrata.
According to the Guardian, Eufor Libya “would be authorised to fight if they or their humanitarian wards were threatened.” The Guardian reports that the current on-call European battlegroup is mostly made up of German troops, but it turns out to be predominantly Dutch, although the Germans are involved. The other battlegroup is from the Nordic countries; predominantly Swedish. French units, in particular, are not involved. Inside a European Union that appears to be straining over economic adjustment and immigration, the politics of this will be problematic. (I for one would like Doug Muir’s insights here. After all, so far we’re both right!)
A French parliamentarian, Axel Poniatowski, has correctly pointed out that in order to be more effective, NATO will need to put spotters on the ground. Reports that the Europeans are running short of precision-guided munitions only make that more pressing; moreover, the Europeans may have to deploy helicopters, which means ground crews.
And that means a need to creatively interpret the U.N. resolution or go back and get a new one. France and Britain seem to disagree on this point.
This is an intervention that should be easy. The rub is that the Europeans really have let their military capacities deteriorate to a rather remarkable extent. Moreover, coalition warfare is extremely difficult; more so, when the allies do not agree. So far, the six bad results have been avoided, including the 7th possibility of prolonged attrition warfare. Conditions in rebel-held territory seem good, and the oil industry is getting organized. But the jury is still out.
Enough, already! Now Steven Walt has joined the ranks of the people stunned by the effect of the internets. “A combination of modern mass media (Al Jazeera, the Internet, email, Twitter, etc.) has clearly played a major role in driving the pace of events.” I could handle this kind of thing from 20-somethings who don’t remember when you had to wait for a letter to arrive in the mail. But Steven Walt?
I am at a loss as to why people keep coming back to the Internets. Here is a chronology of recent events:
Dec. 17 - Mohamed Bouazizi sets fire to himself in Sidi Bouzid, Tunisia.
Jan. 04 - Bouazizi dies of his burns.
Jan. 14 - After days of riots, President Ben Ali flees to Saudi Arabia.
Jan. 22 - Protests in Algeria.
Jan. 23 - Protests in Yemen.
Jan. 25 - Protests in Cairo.
And here is an even more impressive and more rapid chain of events:
Feb. 22 - French government bans protest meetings. Riots break out.
Feb. 23 - Prime Minister Guizot resigns.
Feb. 26 - King flees to Britain.
Feb. 27 - Protest marches in Germany. Governments give into demands.
Mar. 13 - Riots flare in Vienna. Metternich resigns.
Mar. 15 - Mass demonstrations in Budapest.
Mar. 18 - Demonstrations in Berlin.
Mar. 20 - Uprising in Poland.
Mar. 31 - Constitution drafted for Germany.
Apr. 08 - Revolt in Moldava.
The difference? The first group happened in 2010-11, and the second in 1848. But somehow that has gone right into the memory hole. I am flabbergasted that the Brazilian, Philippine, and Chinese events of my living memory seem to have been forgotten. I am surprised that nobody seems to mention 1968. But I really stunned that 1848 has been lost in the frenzy to declare how super marvelicious the internet is for freedom.
I am making a strong argument here: if the internet had been magically shut down on December 17th, events would have proceeded in much the same way. News travels and people organize in ways that do not involve modern electronic communication.
It appears that Germany may be awakening to the disaster that would follow the collapse of the eurozone. Der Spiegel has an issue explaining the disastrous effects on Germany. They divvied them into actual costs (of printing up and distributing a new currency), export collapses, unemployment, and a loss of international power. The article lumps in the problems for Germany’s banks in the unemployment section, which is fair enough: the problem with having Germany’s banks take massive losses on their lending to de-euroized countries is not that the banks would lose money. It is that the resulting increase in risk premiums would cause a credit crunch, drive illiquid-but-solvent firms to the wall, and kill jobs.
To be fair, it is much more likely that the euro would collapse as other countries peeled off in the wake of banking crises. So their first cost is a bit of a red herring, since even an extreme eurocollapse would certainly still leave a rump euro used by Austria, Finland, Germany, the Netherlands, Luxembourg, Slovenia, Slovakia, and (probably) France. That said, for Germany the costs of reintroducing would be small.
That is not true for the countries likely to decide to leave the single currency. They would face massive adjustment costs. My friend Doug thinks they can be avoided. He is right ... if the banking systems in those countries have already collapsed. If the banking systems have gone under, then abandoning the euro is all gravy. The new central banks can reflate and keep domestic depositors whole, while the inevitable fall in the value of the new currency triggers an export boom. There will still be legal issues, since the governments of the countries with collapsing banks will have already likely imposed de facto capital controls (at the very least, a bank holiday of sorts), and that is against European law.
But if the banking system is still alive, then the Eichengreen logic holds: the run-up to de-euroization would see the mother of all capital flight. Everyone and their second cousin tried to get their money out of the de-euroizing country. Yields on government debt would spike to impossible levels; likely debt auctions would actually fail. The result of that would be massive massive government cuts in the run-up: imagine workers paid in IOUs instead of cash. Finally, anyone with paper euros would hoard them, driving the economy back to barter. This all happened in Argentina.
The reason why I think the euro is now 50-50 is that I can imagine things getting so bad that leaving the currency would in fact have few costs, but I want to be clear: the reason that it would have few costs is that they would have already been paid, not that they would not exist. Only the benefits would remain.
If that is not correct, then I think there is an opportunity to make some money explaining why to the Irish, Greek, Portuguese, and Spanish governments. Over to you, Doug.
Ireland is in trouble. Kevin O’Rourke has written an despairing piece on the country’s woes that is, I think, well worth reading. There is a good analysis of the situation up on Crooked Timber; the comments are well-worth reading. There seems to be some question about the extent of German banks’ exposure to Irish debts, private and sovereign. That matters: the less exposed the foreign banks, the easier a solution. (And yes, that is back-asswards from what you would think.) Tyler Cowen thinks the situation is doomed; he even thinks that a unified banking market (which would have helped a lot) is probably now off the table.
Interestingly, the bars in Southie are not full of discussions about the recent Irish loss of sovereignty, as opposed to an older one.
Yesterday’s Financial Times had a nice recap of the E.U.’s options on page 2. Here they are:
Now, the part about Greece is not quite right. In the short-run, exit would be a disaster. But it would lead to an export boom down the line, and if the banking system had already collapsed then the costs would be relatively low. That however, is really a fairly weak nothing-left-to-lose argument: if we ever reach the point where leaving the eurozone is costless for a country, then that country has already been plunged into something as severe as the Great Depression. The real money line is the one about Germany, as discussed in the previous post: a wave of eurozone exits would devastate the German economy.
I had an idea for another option, but it slipped my mind. Anyone know what it might have been?
In my previous post, I wrote, “The problem seems to be the German government’s unwillingness to explain that Germans benefit more than anyone from the eurozone. Break it up, and German banks go kaplooie, German exports become uncompetitive, German wages become unsustainable, and the German people get blamed.”
One reasonable objection might be that Germany depends relatively little on the rest of the eurozone for its export revenue. (See the above chart for German exports in billions of current dollars.) In 2009, the eurozone took only 41% of all German exports. Moreover, much of the eurozone is likely to survive any crisis. The six countries whose new currencies are likely to collapse in the event of a breakup (Belgium, Greece, Ireland, Italy, Portugal and Spain) took only 17% of German exports. Those statistics certainly make it seem that Berlin could afford to let the European Union go hang.
Except ... well ... Germany depends a lot on exports. Exports to the Notorious Six may come to only 17% of German exports, but Germany exported 38% of its GDP in 2009. Exports to the Notorious Six, therefore, came to 6.6% of German GDP. In addition, imports from the Notorious Six came to 5.0% of German GDP. Imagine, then, a devaluation that caused German exports to those countries to drop by a third, while imports from them rose equivalently. The total negative shock to Germany’s economy would come to 3.9% of GDP. That is, I think, quite large. Depending upon the multiplier, the shock could be even larger.
Add to that the negative effect from the collapse of all those German banks that invested in the Notorious Six (plus the huge rise in uncertainty that any European collapse will entail) and the negative effect is likely to be much much larger than 4.9%. Six percent? Eight percent? Your guess is as good (and likely better) than mine. But the numbers look to be at Great Depression levels, unless the German government proceeded to throw its current rulebook out the window and deficit spend as if there was no tomorrow. (1931 all over again!)
Will German voters prefer to pay that price rather then pay to resolve the credit crises currently besetting (or threatening to beset) the Notorious Six? I do not know. I increasingly suspect that they would. Buckle up; we seem to be in for a rocky ride.
I never held much truck with analysts like George Friedman, who believed that the European Union is doomed. Unfortunately, new facts have caused me to change my mind.
One new fact, actually: the European decision to charge the Irish government a market rate on its “bailout” funds. WTF? Here is where I want to go out and shake a German: the IMF is the good guy in this story! You heard me right. The IMF suggested that Ireland basically default on the debt incurred to rescue the banks. That would be fine. Cut everyone’s debt level, let firms and individuals escape via bankruptcy. That would make it much easier to slash prices and wages without squeezing living standards. “Internal devaluation,” in other words.
But the German government, the same government that (sensibly) wants private-sector haircuts after 2013 nixed the idea because its own banks are too exposed, and Berlin does not want to admit that its banks were as caught up in the foolishness as Irish ones. Instead we get a non-bailout bailout that does nothing to improve the situation and forces the Irish public to transfer 10% of its income to the rest of Europe for the foreseeable future.
Maybe as the possibility of disastrous disorderly defaults looms ever-larger, German politicians will get their act together. A European version of the Brady bond is one possible solution. A raise in the ECB’s inflation target would help. Low-interest E.U. loans are a great idea. And a complete unification of European banking regulation (I suggest they just adopt Canada’s rules and be done with it) is long overdue. Internal devaluations made as easy as possible, reforms in the places that need it (of which Ireland is not one), and the dream of European unity held together.
That looks ever-less likely. Instead we may get collapsing banking systems, chaotic defaults, German taxpayers bailing out German banks at high cost, and a reckless euro-breakup with horrible consequences for the world economy. It would also, as best as I can see, leave a residue of massive anger aimed, rightly or wrongly, at Berlin.
The problem seem to be the German government’s unwillingness to explain that Germans benefit more than anyone from the eurozone. Break it up, and German banks go kaplooie, German exports become uncompetitive, German wages become unsustainable, and the German people get blamed. Instead, though, it seems that the narrative of hard-working Germans selflessly sustaining the rest of Europe is too good to resist. And so, we slouch towards catastrophe. (The optimist in me says that it will turn out much better than the 1930s! The pessimist says, yeah, so did the 1980s in Latin America.)
I hope that I turn out to have been right the first time. Can somebody talk me down?
Why am I bullish on Portugal, do you ask? Consider the scenario in the below graph. It assumes that interest rates stay high for two years, a double-dip recession next year, annual GDP growth never passes 2%, and Portuguese politicians never balance the budget. That pessimistic scenario stabilizes the country’s net debt (the light green line shows the debt-to-GDP ratio on the right axis) within four years.
That is not to say that there isn’t a lot that could go wrong. The markets might panic. The E.U. might fail to calm them. Portuguese politicians might fail to cut the deficit at all. Growth might stall out at less than 2 percent. The ECB might fail to keep inflation at the 1.7% these projections assume. But that’s a lot of mights.
Something to note is that with the exception of financial corporations, Portuguese companies borrow at better terms than the Portuguese government. If the markets believed that a Portuguese default was really going to impose crushing taxes on Portuguese companies and wreck their access to capital, then this pattern should not hold. But it does! Of course, I don’t believe much in efficient markets, so I take no solace from that.
You know who should take solace in the pattern, though? The European Union! More precisely, Angela Merkel and crazy German public opinion. If markets panic over Portuguese debt, and yields start to spike, then the E.U. should happily lend Portugal the money it needs to tide it over. They will almost certainly come out ahead.
Moreover, as the markets suggest, the Portuguese economy has some green shoots ready to sprout. Renewable energy and smart systems are the biggest. But there is also a government that aims to preserve infrastructure spending, which bodes well for future growth. Of course, the New York Times would portray that latter as a bad thing. It wrote: “The government’s failure to rein in spending — and its decision to spend on yet more highways and toll roads instead of investments that could produce direly needed economic and export growth — has soured relations with the opposition Social Democrats.”
Huh? Of course, this is the same newspaper that in the same issue was stupid enough to write the following about Mayor Bloomberg’s nominee for chancellor of the public schools: “She has shown a common touch as president of Hearst Magazines since 1995 by riding in yellow cabs rather than black limousines.” So you shouldn’t take their misgivings too seriously.
In short, Portugal is not Greece, and I’m bullish on their prospects. Of course, “bullish” is relative. In absolute terms, Portugal’s prospects aren’t that great. But they are much greater than the doom the markets are predicting, and in this case, I’m willing to take the bet. As is East Timor.
Yesterday, the government of East Timor announced that it would purchase $700 million in Portuguese bonds. (Hat tip: Randy McDonald.) At first glance, that seems kind of stunning. One of the poorest countries on the planet is lending money to a member of the European Union? It sure looks like “an interesting inversion of the standard postcolonial paradigm.”
At second glance, there is a story here, but it isn’t the one you might think. The story is that East Timor is handling its oil boom quite responsibility. The rest is unsurprising. Let me start with the unsurprising part.
First, capital flows from oil-rich ex-colonies to their former metropoles are nothing new. The UAE, Qatar, and Bahrain have been investing a lot of money in the U.K. for quite some time. The nations of French West Africa hold a minimum of 65% of their foreign exchange at the French treasury (and in practice rather more) in essence lending money to the metropole. In fact, such capital flows predate independence: Britain hung on to the sterling zone for a long time because it feared that its colonies would no longer lend to the U.K. without it.
Second, Portuguese bonds are a pretty good investment. The 10-year bond is yielding 6.7% — that’s 2.7 times the yield on German bonds. Unless Portugal repudiates past-due interest payments (and in postwar debt restructurings, only Argentina has done that) bondholders would come out ahead as long as the haircut on debt principal is less than 25%. (To be fair, the math is a bit more complicated, because it depends on when Portugal defaults, but that serves to make the bonds more attractive.) In other words, the East Timorese deal is far from charity.
Third,the purchase has the obvious additional benefit of buying some Portuguese goodwill, which ain’t nothing, considering that Portuguese aid averaged €42.6 million per year between 1999 and 2009. Moreover, Portugal has been cutting foreign aid significantly, so buying goodwill could have a big return. Considering that East Timor will earn €34.4 million per year on its investment, that is a pretty cheap way to buy goodwill.
From Portugal’s point-of-view, however, there is no charity. First, the loan is a drop in the bucket compared to the country’s total debt of €145 billion. Second, the loan is being made at commercial rates, and will involve buying existing sovereign debt, not the provision of new money. Third, it might not all involve Portuguese sovereign debt: the Timorese authorities have added the following weasel words: “Investments could be made in highly successful public or quasi-governmental enterprises that guarantee high returns.” Considering that $700 million is a legal maximum for East Timor, which has to invest 90% of its assets in U.S. Treasury bonds, the implication is that the Portuguese government will get less than that.
In other words, Portugal will get a small amount of help from a source with every incentive to lend it money regardless of political connections. (I suppose East Timor could buy Greek bonds instead.) Not much to feel grateful about. Portugal probably will anyway. That isn’t a bad thing. But it doesn’t make this loan into any sort of new post-colonial paradigm, or give Portugal a serious lifeline. It is, sad to say, a sideshow. Dog bites man.
The real story is that East Timor has the money to invest. Why? Simply that since 2004, most of the country’s oil revenues have been placed into a fund and invested overseas. On average, 82% of revenues have gone into the fund, and never less than 74%, in 2006. (See the above chart.) Considering that Gabon, for example, has made a complete hash out of a similar fund, as have many other countries, that is an impressive achievement. other countries haven’t even tried. (It would be churlish to suggest that the extreme level of foreign influence over the Timorese government has anything to do with the success.)
In the long-run, East Timor is guaranteeing itself a perpetual income around $500 million per year, which isn’t bad for a country of only a million people, although population growth will reduce the per-capita value of that benefit over time. (That’s the shrinking dashed line in the above chart, which assumes $60 per barrel oil.) It won’t solve the country’s many problems, and it may be invested too conservatively (90% in U.S. treasuries? Really?) but if the Timorese government can stick to it, then the oil discoveries have a good shot at promoting the nation’s long-term good. That’s the big news, not the decision to invest in Portuguese sovereign deb.
We aren’t quite returning to normal levels of activity here, but we’re getting close. Things have been busy, what with teaching and casewriting and book-finishing. I still need to complete a book manuscript before the blog fully revives, but I do now have some time to breathe.
And so, I present you with four unrelated links. First, listen to Finland’s foreign minister talk a remarkable amount of sense regarding European defense. Time for Europe to “grow up,” says Alexander Stubb. “I don’t believe the US presence in Europe is permanent. The U.S. is starting to flirt with other partners than the Europeans. The E.U. is not as sexy as it once was. We are like a grumpy old couple. We’ve been together for 60 years. We nag at each other. We might have the same values but America is starting to look elsewhere. If the Americans are looking elsewhere then we have to start up coming up with European solutions, we can’t operate in the security field as 27 different entities.”
Well said. Budget-cutting is turning several Europeans forces into almost ceremonial remnants. He didn’t quite come out and call for a single European army, but that’s the implication. In a world of declining defense budgets, Europe has to decide whether to become a giant Costa Rica (with two nuclear-armed provinces) or try to get more bang for the euro by merging their militaries. The U.K. and France have already begun the process. The more direct politicians are about the choices, the better. (And no, I don’t think that the previous statement is always true.)
Second, Doug Muir is in Zambia! As always, he writes good stuff. The World of Warcraft reference goes over my head, which actually makes it funnier. He discusses Zambian English (which seems to be just another accent), trade with the DRC (which seems to suffer from a severe lack of transport infrastructure, if I’m reading it right), and the European presence. (I met several white Zambians in Mexico a few years back; they seemed healthily attached to the new country, although their accents seemed vaguely British.) He also tells us that Zambia tried to acquire nuclear weapons. That last is not something that I ever woulda guessed. Doug still refuses to carry a camera, though, for his own strange reasons and which I am sure he will regret in 20 years. Anyway, read the posts, and encourage him to keep it coming.
Third, we have Jussi Jalonen on the significance of Kaarlo Kurlo, a Finnish soldier who volunteered to fight in the Polish-Soviet war of 1919-21. It is fascinating stuff, which in a time gone by would have appeared on this blog here. (Yes, that makes me sad. But ni modo, progress is progress.)
Finally, baseball! Word, baseball. You might think that the sport expanded from the United States at the point of a bayonet, since the map of serious baseball countries looks a lot like a map of the unofficial American Empire circa 1940. But you would be wrong. Still no explanation of why the sport faded out in the Philippines.
This is not a post about organized crime in Mexico, although I will be returning to the topic shortly. This post asks simply: given all the things that can go wrong with a fixed exchange rate, let alone a currency union, why do so many countries continue to return to them? After all, when they go wrong, they can go very wrong. You can get horrible explosions like Mexico in 1994 or the Asian currency crashes in 1998, or you can slow grinding meltdowns like the depressions in Argentina around the turn of the century or the Baltic States today.
Yet countries continue to do it. All the West Indies save Jamaica fix to the dollar. Ecuador, El Salvador, and Panama have dollarized. The Baltic States have already been mentioned. Denmark fixes to the euro. The euro itself has no shortage of suitors, even now. In fact, even with the Eurozone’s problems, countries want to form currency unions. East Africa wants to form a currency union. Why?
Well, history is a big reason. The CFA franc, for example, exists and is linked to the euro because of the French non-empire also known as Françafrique. A similar thing can be said about the West Indian links to the dollar. These historical links make it very hard to figure out the effects of a currency link. Maybe countries link to countries with which they trade. Or countries trade more and link with countries with whom they have special political links. All that would make it hard to tell whether exchange rate certainty has a big effect on trade, because causality could run both ways. That didn’t stop Andy Rose from trying, but the results were still highly contested.
Jeffrey Frankel came up with a neat natural experiment. In his own words:
“The long-time link of CFA currencies to the French franc has clearly always had a political motivation. So CFA trade with France could not in the past reliably be attributed to the currency link, perhaps even after controlling for common language, former colonial status, etc. But in January 1999, 14 CFA countries woke up in the morning and suddenly found themselves with the same currency link to Germany, Austria, Finland, Portugal, etc., as they had with France. There was no economic/political motivation on the part of the African countries that led them to an arrangement whereby they were tied to these other European currencies. Thus if CFA trade with these other European countries has risen, that suggests a euro effect that we can declare causal. The dummy variable representing whether one partner is a CFA country and the other a euro country has a highly significant coefficient of .57. Taking the exponent, the point estimate is that the euro boosted bilateral trade between the relevant African and European countries by 76%. It is not doubling, and the timing is not perfect. But it does suggest that the effect on trade among small countries is very substantial even after correcting for endogeneity.”
It is true that the CFA franc is in a fixed exchange rate with the Eurozone, not a currency union. Still, as fixed exchange rates go, this one is very strong. It’s supported by the French treasury and not just the governments of the countries in question. Moreover, these countries are dependent on France in umpteen ways, and their governments would find it very difficult to leave the zone without risking economic and political collapse. So there doesn’t seem to be a strong institutional reason to reject the results. It isn’t quite a currency union, but it is close. So what happened in 1999 between the CFA countries and the Eurozone wasn’t quite an accidental currency union, but it was close. And even if it isn’t a real currency zone, the experiment can shed a lot of light on fixed exchange rates.
So fixed exchange rates promote trade! Great news for those of us with strong intuitions that fixed exchange rates and currency unions should be good things for small countries. Problem is, the quantitative results are a little odd:
First, the effect starts in 1997, not 1999. It is possible that expectations of the fixed rate with the rest of Euroland caused the trade boom, but that seems a little ad hoc. Second, the effect seems to have faded out by 2006. Neither result lets one say with confidence that dollarization (or even fixing to a bigger currency) is a good thing for poor countries. Either the result from the CFA-Eurozone experiment is stronger than it looks (maybe 2005-06 were just bad years, or the authors failed to correct for some important factor), or fixed exchange rates only have brief and transitory effects.
We still have a mystery. Thoughts?
Here’s Chris Matthews and Buck Lee, the director of the Santa Rosa Island Authority in Florida, bloviating about help from other countries “with experience in this sort of thing.” Lee mentioned Denmark, then seemed to check himself.
For crying out loud! I want to shoot myself. OK, people, two things. First, a list of all the oil spills in the North Atlantic region (minus the West Cork incident of 2009):
- March 18, 1967, off Cornwall, England: Torrey Canyon spills 905,000 barrels;
- April 22, 1977, in Norwegian waters: blowout in Ekofisk offshore oilfield spills 126,000 barrels. No shorelines affected;
- March 16, 1978, off Portsall, France: Amoco Cadiz spills 68 million gallons;
- July 6, 1988, in Scottish waters: explosion of Occidental Petroleum’s Piper Alpha rig kills 122 workers but spills no oil;
- January 5, 1993, off Shetland, Scotland: MV Braer spills 621,000 barrels.
- February 15, 1996, off Milford Haven, Wales: Sea Empress runs aground, spilling 511,000 barrels;
- December 12, 1999, off the coast of Brittany: Erika wreck spills 71,000 barrels;
- November 13, 2002, off the coast of Galicia: Prestige wreck spills 460,000 barrels;
- December 12, 2007, in Norwegian waters: Statfjord offshore field spills 25,000 barrels;
- July 31, 2009, off Telemark, Norway: Full City wreck spills 1,440 barrels.
In other words, they don’t have all that much experience with cleaning up oil spills in the North Atlantic, because they seem to be pretty good at preventing them. Only one of the spills came from a blowout, and none of the oil there reached the shore.
Second, European countries have sent us what they could, and we have accepted it. There is no foreign savior waiting in the wings, being kept out by some weird combination of red tape and nationalism.
So enough with the idiocy already. The Europeans are better at keeping spills from happening; they have neither special expertise nor deep stores of special equipment to clean up the resulting mess. Somebody tell Chris Matthews, please?
A long time ago, the group bloggers over at a Fistful of Euros gave me the okay to join them. I turned it down. Who needs a bigger platform? People might notice when you say something dumb. I felt very good about my decision when the New York Times wrote about “the influential Fistful of Euros blog.” (Didja know about that, Doug?)
That said, being obscure has its downside, especially since nobody will answer your question: why would Germany want to leave the eurozone? Edward Hugh said it again. Others have intimated it. But nobody explains why this would happen! Now, I know Ed is important and all these days, but I really would like to know why this logic is wrong. C’mon, Ed, somebody, help a brother out. Alex, can you poke him again?
I've already mentioned how German public opinion about the economic crisis in southern euroland annoys me. “Poor naïve Klutzes” my foot. The truth is that Germany has greatly benefitted from being able to force its eurozone partners into a monetary policy that generated speculative bubbles and drove up their price levels. A nice essay on the topic can be found here.
One thing that I do not understand are the strange allusions that Germans might benefit from leaving the eurozone. Their exchange rate would rise, making their exports uncompetitive and reducing the value of their substantial holdings of foreign assets. I suppose that those assets, denominated in euros, would be a bit safer at the new values ... but I am still not seeing it.
I do not know if Spain can survive inside the strictures of the eurozone. I suspect that it can, but I do not know. I certainly am beginning to revise my priors on the worth of the single currency. That all said, I still find the sanctimonious German attitude most annoying. The bailouts will not cost the German taxpayer a nickel, the PIGS will be forced to reform their labor markets, and Germany will continue to enjoy the benefits of export competitiveness for several years to come. The worst thing that could happen to Germany would be slightly higher inflation ... and that would be a good thing for German pocketbooks, if not for Germany’s pathological public opinion. I mean, when the head of the Austrian central bank calls German inflation fears “hysterical,” then something is wrong.
I find the German response to the euro crisis irritating in the extreme. German taxpayers will not lose money in providing support to Greece, even when the inevitable haircut comes along. German exporters benefit from the eurozone. Avoiding competitive devaluations is a good thing; the single market is (I believe) unsustainable in the long-run without exchange rate stability. Etcetera. Sanctimoniousness gets you nowhere; they have become a country of Alfonse D’Amatos.
Truth is, the fiscal problems of the eurozone are small beans. They would be there even with flexible exchange rates, and Germany would still be making the (repeat: profitable) loans needed to tide the southerners through. See Mexico 1995.
But there is another truth, which is that Spain is in serious trouble. Why? Simple: wages far outran productivity over the past decade.
A bit more detail: Spanish wages are set under the 1980 Worker’s Act. Bargaining generally takes place at the industry and province level, with agreements covering all of a province’s firms in a given sector. (The provinces are smaller than the “autonomous communities,” which are what most foreign observers probably think of when they hear the word “province.” They’re the rough equivalent of a U.S. county, with the municipalities being more like eastern townships.) Such agreements cover about half the labor force; another quarter are under industrywide agreements negotiated at the national level. Details here.
Industrywide negotiation is already a problem. High-productivity firms like generous agreements, since they hobble the competititon. Low-productivity firms might prefer to negotiate on their own, but once they get locked in, they have less incentive to fight a generous agreement since they know that their competitors (good or bad) will be equally disadvantaged. Worse yet, if no agreement can be reached, the existing agreement (along with its escalator clauses) is automatically extended ... about a third of the labor force is covered by agreements that effectively last more than two years.
Labor economists have found (and found again) that completely centralized national wage bargaining often leads to wage restraint. So does decentralized firm-level bargaining (or, more accurately in the American case, an almost complete lack of collective bargaining). The worst outcomes appear in Spanish-style half-centralized systems. The (unsatisfying) explanation is that a national labor union internalizes some of the problems of national industry: killing troubled firms to benefit good ones does not benefit them.
In short, Spain is neither Florida nor Sweden. When there is a shock to Florida’s economy, wages plummet because workers are powerless. (Real wages fell 2.5% in 2009.) When Sweden has a shock, the unions (thinking nationally) accept wage restraints. Spain, neither.
Which means that it is going to be tough push wages down enough. In fact, it will be tougher, because Spain has such high levels of personal indebtedness: grinding wages down will smack Spanish banks right in the face ... and by extension the foreigners who have lent to them. (See Felix Salmon for more on this point: private debt is as big a problem as public debt.)
Now, Spain can adjust. But it will be hard. It would be nice to see the E.U. seriously thinking about the problem. Instead, we have posturing Germans. I am much more sympathetic to the Spanish governments ranting about speculators, because the truth is that Spain can bring its public debt into line even if growth grinds to a halt. But growth grinding to a halt is a bad outcome. Breaking up the eurozone still looks like a worse one, so in the absence of any kind of collective spirit, a grinding painful lost decade is what we are going to get.
Unless we grind along too long and a Spanish government decides that leaving the E.U. is a better option ...
I met Anna Gelpern at a conference on sovereign debt held at American University in Washington, D.C. She is one of the smartest people I’ve had the honor to meet, so when she writes that the giant E.U. move towards federalism makes her believe that Greece can avoid default, you should listen to her. Albeit not about the weather.
Thing is, the numbers for Greek debt dynamics are still pretty damn grim, almost as grim as the weather that day in D.C. If growth doesn’t materialize by 2012, all bets are off.
So when I mentioned the “imminent collapse of the Eurozone” my old Army buddy Malachi Wolfe expressed some surprise. “Awww man you're kidding me,” he said. Some academics also seem surprised. When I sent an email around to HBS professors noting this story, a Spanish colleague said, “It’s only one observation. Maybe the manager’s bonus depends on deposits. What bank is it? I’ll move my money into a bank paying four percent.”
Sadly, no. I am not kidding. And while I am going to try to move some money into Spanish banks, I would be lying if I said that I was not nervous about it.
The above are nominal yields on two-year bonds. (The eurozone countries that are not in chart are paralleling France and Germany.)
Brad Delong: “In Europe, the Creditanstalt's bankruptcy and what followed was what turned the recession into the European Great Depression...”
The Portuguese for Creditanstalt is “Instituição de crédito.” A few days ago, events reminded me of 1982, and the onset of the Latin American debt crisis. I am now getting a frightening whiff of 1931. Somebody please tell me why I’m wrong.
Thanks to reader BPH for catching a major bonehead error in comments. The mistake is now fixed. Apologies!
The title of this post is a question asked me today yesterday by a Columbia student Guy Tower. The correct answer is probably, “to express an unfocused floating rage,” followed by “a miracle.” In fact, the last time Amma and I were in Greece, the place had just been hit by riots. That said, there are three possible concrete things that a tear-gas-dodging rock-throwing rioter might actually want the Greek government to do.
In order of reasonableness:
(1) Make sure that rich Greeks pay there fair share of the adjustment burden. Sure, taxes amount to only 32% of GDP ... and that assumes that GDP is properly measured ... but tax rates in Greece are not low. Tax collection is low. Considering how royally Greek governments have screwed up tax collection, anger at this would get me on the streets too. Raising VAT when you can’t collect a swimming pool tax? WTF? Bring in Crown Agents!
Don’t forget that Greeks are poor. (Albeit not as poor as in the first version of this post! Thanks again to BGH.) The below chart gives the bottom nine deciles of each country’s income distribution, in euros per year at PPP. The median Greek would fall below the Austrian, British, Danish, Dutch, and Swedish poverty lines. They would be in the bottom 30% of the income distribution in Belgium, Cyprus, Ireland, France, and Finland. The lowest tenth of the income distribution is poorer than anywhere else in the Eurozone except Italy, Slovenia, Spain, and a very few Cypriots.
In short, Greeks have ample reason to suspect that rich people are getting away with murder, and ample reason to be angry about it.
(2) Push back on the creditors. Yes, Greece has been irresponsible. Hell, it’s been malfeasant. But recent months show all the characteristics of a credit spiral, when bad things happen to good countries. (Or in this case, a badly-behaved one.) If were Greek, I’d want the Greek government to take a harder line with its creditors. Extend maturities, reduce interest payments, basically make ‘em take a haircut. Another way to think about this is that if Greece were a corporation it would be in bankruptcy protection right now. Greece would still need to make budget cuts (its interest payments are lower than its deficit) but they would be less painful and much more politically palatable.
(3) Get out of the euro.
Okay, that last one is crazy. What would Greece need to do to leave the euro? Well, it would have to freeze bank deposits, in order to prevent a flight of cash to the rest of Europe. The problem with that is that doing so would violate European law — Greece would need either a special mulligan from the European Commission (which would set an awful precedent) or quit the Union altogether.
Of course, it is possible that runs on Greek banks will happen anyway. Thing is, the ECB is moving to prevent that, by continuing to accept Greek bonds. Even if the ECB fails, rumors of euro-exit could produce something far worse than bank runs: consider what happened to Argentina in the run-up to its big devaluation. If Greece looked to be reintroducing drachma, nobody would want to spend euros. After all, they’d all be expecting the drachma-euro exchange rate to plummet the second the drachma became legal tender. The economy could go back to barter in the run-up. That happened in Argentina in 2001.
I’ll also add that a devaluation would almost certainly be connected to a default. I’m having trouble seeing Greece suddenly enjoy an Argentine-style export boom without a big drop in the nominal exchange rate. The problem with having a debt burden at 113% is that a big drop in the nominal exchange rate means a big rise in debt burdens, since Greek debts are denominated in euros. Either Greece redenominates its debts — a de facto default, unless the European Court decides doing so is illegal — or it will have to renegotiate them.
In other words, a Greek ejection from Euroland might be good for Greece ... in the sense of being terrible but better than some other possible outcomes ... but it seems to me that it would be rather bad for the rest of Europe. We have, in fact, seen a similar movie before.
Anyway, it seems to me that there are reasons to oppose the current government that go beyond simply wishing for a pony. The 1980s really weren’t really that great a decade. I would like to see more of (1) and (2), with a much more pro-active Brussels. Guarantees for Greek banks would help. (Make ‘em adopt Panamanian banking regulations, and I mean that quite seriously.) More quantitative easing from the ECB. An inflation target of 2%, not just a ceiling. Hell, a target of 3½ percent. British officials running around inside the Greek tax administration. Some of European version of the proposed Sovereign Debt Restructuring Mechanism; e.g., a bankruptcy procedure for E.U. countries.
None of which (except maybe implicit bank guarantees) is going to happen, thanks to Angela Merkel. So unless the Greeks want to flirt with depression and expulsion from the E.U., we are stuck with muddling through. And that means, at some point, a default.
Good luck, madre patria.
The short answer to Bernard's question about Oxy is that they bid too high. They were the minority partner in a field with Eni, Sonangol, CNOOC and Kogas ... and they lost.
The rest of the final post in the Iraqi oil series is going to be held up for a bit. The reason is left for an exercise by the reader, but it is a good one. The worst case scenario is that you will see it here fast.
This month begins a horrendous travel month during which I will go from Boston to Los Angeles to New York to Tulsa to Shamrock TX to Burlington to New York to Miami to Atlanta to home and my wife!!! (Who will be visiting me in both New York stops, thank the Lord.) France was much more fun. Oddly enough, I'm really only looking forward to the Tulsa-Shamrock bit of the trip, although I will enjoy smoking cigars in New York and Miami with my hermanos if I get the chance.
As someone who has a great affinity, even a love, for both Britain and France (maybe it's a color-combo thing, or a losing land wars in Asia thing, or some else ... thing) I present you with the following:
|The Daily Show With Jon Stewart||Mon - Thurs 11p / 10c|
|Sarkozy Visits the U.S.|
I eagerly await the Ranter's informed commentary.
Why is the Icelandic taxpayer on the hook, asks Jonathan? The short answer is: blame Europe!
Everyone knows about the European Union, the big confederation (with some federal characteristics) of countries sitting there on the Old Continent. Fewer people know about the European Economic Area. The EEA is basically an agreement under which Iceland, Norway, and ... er ... Liechtenstein get access to the European market in return for adopting some E.U. laws and regulations. (Switzerland has basically replicated the same arrangements without formally signing on to the EEA.) The EEA required its members to adopt European law on deposit insurance in return for granting EEA banks the right to branch into the E.U. As a result, Iceland adopted a deposit-insurance scheme in 1999.
Click the link on the Icelandic scheme. (Or keep reading.) Scroll down to Chapter 5, Article 10. It reads: “This amount shall be linked to the EUR exchange rate of 5 January 1999.” The reason is quite simple: the E.U. law required countries to create schemes that insured deposit accounts with a value of at least €20,000. Ergo, the Icelandic scheme guaranteed €20,887. Now, the scheme was financed by a 1% levy on bank deposits and was rather vague about what would happen if it could not meet its obligations. Was the government then responsible? Were savers then on their own? What?
The 300,000 British depositors who fell in love with the 6% rates that Landsbanki offered through its “Icesave” accounts did not seem troubled by these distinctions. They deposited £5 billion. In an Icelandic bank. A bank they had never heard of before 2006 based on a tiny island of 300,000 people. Any resemblance to Barbados is entirely coincidental. Barbadian banks do not do this sort of thing. This may be because Barbadian bankers have banked for some time, while the Icelandics were pretty green.
Maybe the Britons thought that Iceland was in the Caribbean? More likely they were taken in by a message that Britain’s financial regulators allowed to stand on its website: “You can also rest assured that with Icesave you are offered the same level of financial protection as every bank in the U.K.”
Well, when Iceland finally went kablooie, worried Britons began a run on Landsbanki, which led to a rather remarkable conversation between Iceland’s finance minister, Árni Mathiesen, and Chancellor Alistair Darling of the United Kingdom:
Darling: “Do I understand that you guarantee the deposits of Icelandic depositors?”
Mathiesen: “Yes, we guarantee the deposits in the banks and branches here in Iceland.”
Darling: “But not the branches outside Iceland?”
Mathiesen: “No, not outside of what was already in the letter that we sent.”
Darling: “But is that not in breach of the EEA treaty?”
Mathiesen: “No, we don’t think so ... Since we can’t cure the domestic situation, we can’t really do anything about things that are abroad.”
Darling: “See, I need to know this in terms of what I tell people. It’s quite possible that there is not enough money in [Iceland’s depositor guarantee] fund. Is that right?”
Mathiesen: “Yes, that is quite possible.”
Darling: “You have to understand that the reputation of your country is going to be terrible. It really is a very, very difficult situation where people thought they were covered and then they discover the insurance fund hasn’t got any money in it.”
After hanging up the phone, Darling did something even more remarkable: declare Iceland a terrorist state. It was the easiest way to freeze Landsbanki assets inside the U.K. (Sadly, most of Landsbanki’s assets were not in the U.K.) He then guaranteed that British depositors would be repaid in full. Good politics, of course, and probably needed to prevent crippling bank runs in Britain, where a lot of foreign banks operate.
At that point, Darling went back to Iceland — which desperately needed financial support from other Nordic countries to prevent runs there and obtain IMF money — and convined them to pass a bill that would pay Britain back for the money it spent supporting the deposits of its citizens who had placed their money in the banks of a terrorist state. Icelandic voters, for some reason, were miffed by that ... and the result was the referendum.
What happens now is anyone’s guess, although I am fairly confident that my most excellent proposal will not be adopted. Answer your question, LT?
So, the Icelandic electorate today told the British and Dutch to shove off. The mess is about the bill for Iceland’s spectacular bank collapses. The Anglo-Dutch governments made their depositors whole at a cost of approximately $16,500 for every man, woman, and child in the Republic of Iceland. The “no” vote appears to garnered 93%. A last-minute Anglo-Dutch offer to cut the interest rate on the debt from 5.5% to 2.75% does not appear to have generated much sympathy among Icelandic taxpayers.
It isn’t clear what the referendum means. “We want to be perfectly clear that a ‘no’ vote does not mean we are refusing to pay,” said the Finance Minister. In other words, Iceland will probably pay anyway. Nonpayment would hold up an IMF loan and put off the day when Iceland can lift its capital controls and return to some semblance of economic normalcy. It would also imperil (maybe even kill) its chances to join the E.U., let alone the eurozone.
In light of all that, I would like to resurrect my proposal that Iceland resurrect the Icelandic Commonwealth, this time in the form of the Commonwealth of Iceland. The numbers add up. It makes sense for both Washington and Reykjavík. It would end any need to go to the IMF. The deal could be unwound unilaterally at any time. There isn’t even any need to go the fully-irreversible route on citizenship: the people of American Samoa are U.S. nationals, not citizens.
Sounding more win-win to me every day. Just like having Britain give its security council seat to India.
Two days ago, in a Financial Times column that was bullish on the long-term potential of the Indian economy, Martin Wolf said something very sensible:
“Exhausted by the burden of its pretensions, the U.K. should soon offer its seat on the Security Council of the United Nations to its former colony. Its condition would be that France does the same in favor of the European Union.”
Yes, indeed. Too bad that Mr. Wolf and myself are in agreement that it won’t happen. But still. What does Britain get out of its seat on the Security Council? Countries with rotating seats, like Mexico, have often found it more of a pain than a benefit. (It makes neutrality difficult.) Small countries get a monetary benefit as the U.S. bought their votes (joined in the old days by the USSR, and probably the PRC in future ones.) And I can imagine that France likes the insurance policy of a veto; after all, it does have a penchant for randomly invading African countries. But the U.K.? Why bother? Sell it to India.