BlogSpot - Grexit and QE talks... again!
That Grexit talk again
Noise around Greece continues to be loud—with an upcoming visit of the Greek prime minister to Germany (DW), discussion about the personalities of the actors (Münchau’s column on Varoufakis’ vanity), the Paris Match photos of Varoufakis (EuroIntelligence), creditor talks (Bloomberg), etc. Jacob Funk Kirkegaard (Peterson) reviews the recent events and argues that the recent developments and economic reality are forcing Syriza to the center, with risks of radicalization. RealTime Brussels provides a useful glossary of the new terms used to discuss the Greek situation, from the “Brussels Group” to the “Constructive Ambiguity.”
The field of alternatives to the current program is wide. Wolfgang Munchau writes that the probability of a Greek exit has risen significantly (a point of view shared by Morgan Stanley):
Transitory regimes—Munchau recommends a smoke-and-mirrors system where nobody can tell whether the country is in or out of the eurozone, providing more time and more flexibility, with an interim regime in the form of a parallel currency. Wolfgang Munchau sees opportunities in using crypto-currencies (e.g., Bitcoins) as parallel currencies because of their deflationary bias.
Grexit—Erik Nielsen sees Grexit as a cleaner option to a disorderly unfolding of the Greek economy when it runs out of money—but that requires preparing: currency conversion, capital controls, government default on all claims on foreigners, including the IMF, with a long transition out of a very deep recession, yet better for Europe than a disorderly exit.
Grexident—The worst outcome would be a chaotic exit – a Grexident, which, according to Goldman Sachs, Schäuble sees as resting completely with Greece. Hugo Dixon and Wolfgang Munchau, as reported by EuroIntelligence, disagree on the viability of an alternative strategy. Dixon believes that Greece can only work with its euro creditors to reform the economy, and abandon most of the election promises—with Grexit a more costly option and default inside the eurozone leading to a general bankruptcy.
For Ricardo Hausmann (Project Syndicate), the bottom line is that Greece needs to develop its productive capabilities if it wants to grow, and this is not provided by the unfocused set of structural reforms prescribed by its current financing agreement—Greece should concentrate on activist policies that attract globally competitive firms, an area where Ireland has much to teach. Miroslav Beblavý, in a CEPS commentary, established a simple analytical framework that can be used to assess the likelihood that a government will deliver on its reform agenda—which emphasizes the importance of capacity to design and deliver policies, but also on state autonomy from both illegitimate and legitimate interests.
The wonders of QE
QE has shown massive immediate effects across fixed income and FX markets (significant bull flattening and further EUR/USD decline), which Erik Nielsen explains by two key factors: first, the intensity and concentration of the ECB program (by September 2016, the Eurosystem will be holding about 14% of the entire marketable debt outstanding of the EMU, equivalent to what the Fed accumulated during its entire QE operations during almost six years), and second the ECB started with a bang (EUR 9.8bn of bond purchases). Martin Sandbu (hat-tip EuroIntelligence), looking at now-casting models, suggests that eurozone GDP growth has overtaken US growth during Q1—vindicating the ECB’s QE policies. Manuals on how QE will work have started emerging, from Diego Valiante (EconoMonitor), to Grégory Claeys, Alvaro Leandro and Allison Mandra’s detailed manual. Angel Ubide (Peterson Institute) finds that QE is working well, through standard channels:
Signaling effect and confidence—Markets are expecting the ECB to keep the short-term policy interest rates at or below zero until at least early 2019.
The interest rate channel, portfolio rebalancing and wealth effects—Karl Whelan (Bull Market) asks whether QE will have further effects on interest rates—looking at evidence from the US (e.g. this and this), and finds many unanswered questions—in particular, whether effects are already priced in. Drawing on a paper by Christoph Trebesch and Jeromin Zettelmeyer, he argues that works through a pure “brute force” effect — with an effect on yields of purchased sovereign bonds and no spilling over into other bonds. The decline in nominal bond yields in the periphery (Portugal’s 10-year rates are now below those in the United States and Diego Valiante (EconoMonitor) notes a decoupling of interest rates between Greece and other peripheral countries), zero or negative yields in selected corporate bonds, plus the rally in European stock prices reflect this rebalancing. Willem Pieter de groen, in a CEPS brief, argues that QE is an opportunity to break the sovereign-banking loop, by applying a large-exposure requirement also to eurozone government debt, given the low probability and high loss-given government default—this would imply a 3.2% (€63 billion) reduction in eurozone government debt portfolios, providing further assets for the ECB’s QE.
The exchange rate channel—The trade-weighted euro has depreciated over 12 percent since mid-December (see Goldman Sachs). Matthew Dalton (RealTime Brussels) reports that the weaker euro has already raised European exports to the U.S. shipped by UPS by more than 10% compared with a year ago. David Keohane (FT Alphaville) writes that the combination of ECB easing and negative rates with Europe’s (read: Germany’s) huge excess savings (projected to hit €300bn in 2015—the Euroglut) generates massive capital outflows, in the form of portfolio outflows mostly towards the Anglo-Saxon countries—and (based on a Deutsche Bank analysis), like Japan, Europeans will need to turn into net creditors to the rest of the world to mirror structurally higher saving preferences. This suggests that euro weakness — along with a more general pressure on foreign asset prices, bond yields — is here to stay, with outflows exceeding the euro area’s current account surplus. Paul Krugman takes a different view that the main driver of exchange rate movements is the perception of permanent European weakness—a situation in which Europe will have its fall cushioned by trade surpluses, but the rest of the world will be dragged down by the counterpart deficits. Angel Ubide (Peterson Institute) looks at how Germany could alleviate this situation, suggesting that a program of reforms and public investment would allow to both reduce its external imbalances, contribute to global economic growth, while offsetting some of its future population decline. But he writes that such a program is much more costly politically than the current strategy of fiscal austerity and wage moderation.
The budgetary channel—Paolo Mauro (Peterson Institute) writes that the budgetary windfall from low sovereign yields provides a window of opportunity to be used wisely—public debt reduction, support to the labor market in Italy, increasing physical capital accumulation in Germany.
Ubide adds that tailwinds are benefiting QE—the recent improvement in indicators, the asset quality review and stress tests, the payoffs from the painful but needed extensive fiscal adjustments and reforms in the euro area periphery. Furthermore, Alessio Terzi (Bruegel) reflects on the impact of QE on structural reform efforts, and whether it is reducing pressure on incentives for structural reforms (German Council of Economic Experts, 2014). With empirical data, he finds that the crisis mechanism put in place by the euro area seems to be well equipped to step up reform efforts and that the ECB’s QE seems unlikely to lead to a disproportionate setback in reform efforts in stressed countries.
The Short View…
Anders Aslund (Peterson) reports on the IMF approval of an Extended Fund Facility for Ukraine—a 4-year financial stabilization program that provides $17.5 billion in financing for a total financing needs at $40 billion—which he sees as a chance for Ukraine to reform, despite high downside risks. FreeExchange criticizes the agreement as too heavy on conditionality.
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