After the summit

The EU summit has been generally deemed a flop.  And indeed,  a two day event with  27 european leaders who then go home empty handed cannot be considered a success.  Such meetings should be so prepared as to ensure that  agreement is reached.   At the same time we cannot ignore Europe’s plight.  Not only is the continent in recession, but more than ever before, the differences regarding the scale and direction of further integration is splitting the EU into distinct camps.

The UK is now exceptionally euro sceptic and a summit which could have shown an isolated David Cameron,  merely served to fuel euroscepticism.   At least the UK did not use their veto and the feeling that it was the only the fault of the UK that an agreement was not reached was avoided.

The summit also managed to significantly bridge the gap between those in favour of austerity and those in favour of increasing the budget.  From the perspective of the net payers, the 30 billion euro haggled over concerns the principle more than the substance as this expenditure will be spread out over the next seven years.   In other words four billion euro a year borne by all payers.  These are nominal sums, although for Poland these are much more significant than for the net payers because of the differences in nominal GDP.  As the cost of living in Poland is now at 64% of the EU average, that figure takes into account the lower cost of living.   Nominal comparisons are considerably less advantageous for Poland – our income expressed in euros is on average three times lower than in Western Europe.   Hence the big difference lies in what those figures mean to us.  For the richer countries it’s a nominal figure, for us it’s not.  The whole fight over the budget in Europe no longer concerns just money but shows that during times of crisis, austerity should be applied across the board.  It is difficult to convince Dutch or German voters that when Europe is in recession, more money should be spent on cohesion programmes in central and eastern Europe or on rich farmers in France.  Member states contribute around 1% of GDP to the EU budget.  which means that growth or decline in previous spending levels has little impact on most countries.    That is why Europe has  split into the pro-austerity North and the pro-spending South.  This time Poland has ranked with the South.  In the long run this will not serve us in other areas such as budgetary discipline, competition or deregulation of services – areas where we should unequivocally be supporting the North.  It is all the more important from the perspective of Poland’s position in the Union in ten years’ time.

Our unflagging pro-european stance and associated member status would be a factor which could considerably improve our position in Europe and in the immediate future would mean an improvement in our negotiating position.  Over the next months one of the elements of our negotiating strategy should be this very aspect.  For this places Poland not only in the position of a country needing these funds for its development but above all in the position of a country which will soon be an important partner.  We would do well to remember this.

It is unlikely that during the next summit the parties will not reach an agreement.  Now they are casting around for a compromise worded in a way which will allow the majority of participants to return home crying victory.  The main players at the summit clearly considered that this will be easier to achieve by spreading out the whole discussion over two phases)  The task at hand is to adequately prepare the next phase.

About the Euro

 

There has recently been an increase in the number of myths surrounding the euro, the most widespread being that the common currency is to blame for all the problems now facing southern Europe.  This is based on the following premise:  if there were no euro, there wouldn’t be a crisis.  It is even being suggested that current economic problems can be solved through the simple expedient of a planned dismantling of the common currency zone.  It is being suggested that such a remedy would immediately restore those countries’ competitivity and rich countries would not have to support them financially.  It is an open question whether or not such an operation would indeed increase Europe’s prosperity or on the contrary lead to the need for considerably greater transfers than is now the case.  I doubt the efficacy of such a move, mainly because of the huge costs involved, not to mention trade obligations.  Beyond this kind of question, it is also important to take into account how the eurozone is viewed by the man in the street.   European public opinion polls show that support for the common currency in Europe dropped by 60% in 2007 to just over 50% now.  In Poland this trend is even stronger.  In 2012 only 25% of the population favoured adopting the euro while just two years ago this figure was over 50%.  This is a strong incentive for politicians not to mention the euro.

 

Lately, a member of the British cabinet asked how it’s possible to table a proposal which can be seen to have no backing in the community.  This was not only about the UK joining the eurozone, but also about pending integration issues, including that of the EU budget where the UK views things very differently from most Europeans.  On that issue, I believe that there are fundamental questions – including amongst other things the future of the european project – where it should be the politicians themselves who should be shaping public opinion.  An excellent example from our own corner of Europe was the referendum on Poland’s membership of the EU.  In that referendum the actual turnout was critical.  It was high, thanks mainly to voting being spread out over two days, giving a 58% turnout and 77% support for membership.    Czytaj dalej

EU negotiations – what is it all about?

 

During the last EU summit the British Prime Minister said pointedly that he wasn’t there to make friends but to defend taxpayers’ interests and the interests of Great Britain in the common market.  Strong words.  In this way he clearly announced his intention to veto any budget which opened the door to more spending but the European Union’s work is founded on compromise and such categoric statements are unwelcome.  They can be seen to be chips in the negotiating game but this time in the case of Great Britain, they stem from a deep conviction that just when everyone is trying to save, it would be absurd to increase european budgetary expenditure.   Sometimes it pays to be firm but a reputation for being difficult won’t help to sort out other problems further down the line.

 

Like Poland, the UK  has reservations of principle on a banking union but these objections are founded on a different premise.  Most banks operating in Poland are subsidiaries of large european conglomerates and the new banking union rules would wipe out the possibility of the Polish Financial Services Authority exercising proper supervision of their activities.  For its part, the UK – Europe’s banking heavyweight – does not want to lose influence on second order banking regulations.  Forty percent of european banking assets are in Great Britain.  Added to this is the franco german squabble about the timetable for introducing the banking union.  Rapid implementation would trigger the whole aid mechanism package according to which aid for Spanish banks would not be linked to public debt which would be an advantage for other countries too (in particular for Ireland where the massive growth in debt was caused by the cost of rescuing the Irish banks).   For Germany such a solution is nothing other than guaranteed aid and they are in no hurry to proceed as most probably this would not help Chancellor Merkel in the parliamentary elections planned for next year.  We should ensure that our interests are reflected in the negotiations for the EU spending framework.  Czytaj dalej

Euphoria rules

 

 

It’s again become impossible to know whether to laugh or cry.  One day the markets react with disappointment to ECB President Draghi’s vague statements (despite his declaring unequivocally that there is the possibility of buying up government treasuries on the primary market) – the next day markets are bursting with euphoria when the Spanish premier says he would consider accepting such aid from the ECB.  Unsurprisingly this logic defying display is completely over the head of the man in the street.  

 

In the meantime, of all the CEE countries, Poland is looking good.  Bond yields are at record lows.  The government recently issued ten year bonds at 4.7%.  This is low compared with such countries like Italy and Spain which have to borrow from the markets at 6 and 7 %. 

 

This is also not much higher than the current rate of inflation in Poland.  In buying Polish bonds, investors take into account the likely inflation rate a few years from the date of purchase.  Such optimism against a background of pretty dynamic prices bears witness to a high degree of optimism which leads to results such as the record level of the zloty to the euro (now around 4 euro – a level not seen since August of 2011).  We still can’t tell if this is a passing phase or a stable trend.  I would like it to be the latter but based on experience this is unlikely and as all passing phases, this too shall pass.  I have enjoyed the comments coming from City of London financiers who are capable of singing the praises of the Polish economy (relatively low debt, economic growth, strong domestic demand, a stable and responsible government) while closing zloty positions, citing slower growth, problems in keeping the deficit in check, a large portfolio of Swiss franc debt and a growing number of foreign creditors holding Polish bonds.  The market situation dictates the way events are interpreted.  When the euro falls, it will bring the zloty down with it.  We should view any mood swings with caution and not fall prey to euphoria.  It’s fairy dust and the same goes for the reactions to ECB statements or the lack thereof. 

 

In the markets one thing always holds true:  the financial markets like liquidity and will nearly always react positively in the short term when there is extra cash available whatever its source.   But according to another basic economic principle, monetary policy cannot create economic growth all by itself.  The appropriate economic policy can neither support nor hamper economic growth, but will not create growth out of nothing.  Mario Draghi is perfectly aware of this in appealing to governments to implement their planned reforms – liquidity will depend on this.  But as usual no one is paying attention.  The majority of politicians and market players are concerned with getting cash flowing here and now.  This will probably soon happen – Draghi just needs a little time to agree the principles with his German colleagues.  Then pre-announced moves can be put into action.  Even if he does not manage to thrash out an agreement, he will not leave Spain and especially not Italy without in the lurch.  The only thing is that this doesn’t solve the crucial problem of growth although undoubtedly most politicians will declare an end to the crisis as the ECB starts buying up Spanish and Italian bonds in bulk until …

 

… until market indicators worsen once again or until it is obvious that the market still doesn’t believe in the integrity of the euro zone and places France into the group of countries which have to be financed by the ECB.  What then awaits is a repeat of the current discussion, with the risk that there will be much more at stake – this time the very raison d’etre of the common currency.  The problems of France will automatically become the problems of Germany with all the consequences including partial loss of credibility and German bond yield increases.  Now German bonds are considered to be the safest in the world.  In the face of such a scenario, even Germany might opt for the collapse of the euro zone because it would just cost too much to prop it up.  Unfortunately the next steps in the race against the clock to save the euro are increasingly costly and riskier by the day.  We should repeat ad nauseam that the countries involved must beat the recession alone.  This is possible – one only need look to the example of the Baltic countries, to Ireland, and surely soon to the UK.  The advantage that these countries have is that they believe in one fundamental principle which is not the case in the countries of southern Europe – you have to go it alone and not count on anyone else.

  

Things have just got worse … again

 

Last week saw in a whole raft of very disturbing news.   Once again disaster was on everyone’s lips  while others said "I told you so".    In the eye of the storm was the news that Sicily and Valencia needed bailouts and that the yield on 10 year Spanish bonds had risen to 7.75%.  Spain is days’ away from bankruptcy and will be forced to ask for much more help than before  - probably around three to four hundred billion euro in order to finance the country’s basic needs.

All eyes are now on Italy where premier Monti’s declining popularity will shortly turn into a serious economic problem.   He has introduced  a number of essential and unpopular reforms, but six months after his team of experts took over the helm, the markets are once again demanding the same bond rates as at the end of Berlusconi’s reign.  Hence the question going around Italy now is "what was the point of Monti, sweat and tears if nothing has changed since Berlusconi?"  As I have said many times, the crisis is more political than economic because economic growth all depends on political resolve.  Italy’s problem is that there were no parliamentary elections resulting in a pro-reform majority, for against this backdrop of shrinking approval ratings, the government will find it increasingly difficult to get Parliament to approve any reasonable measures while markets expect a drying up of liquidity as is currently the situation in Spain.  At least a year will have to go by before the fruits of Monti’s reforms can be seen.

Fresh elections will not be enough, the only things that matter are the speed and depth of reforms.  The Spanish government is at last making the right changes but it is almost half a year too late.  The markets no longer believe that these reforms will spur growth in the short term.  No one is expecting any green shoots in Spain for at least two years.  The economy is falling into an ever deeper recession – the end of bad bank debt is nowhere in sight, not to mention the  financial problems facing Spanish regions.  The autonomous regions account for almost 40% of public finances.  For years the banks and the local authorities benefitted from the property boom but with today’s shrinking market they are both experiencing ever greater losses.  It is difficult to expect that in the short term this trend will change in any way.  However this time around, compared with Greece or Portugal, the sheer scale of the financial problems is impressive. Things have just got worse  …  again.

Last week  a member of the ECB Executive Board and then its President indicated how serious things were when they said that the ECB will defend the euro at all costs.  The director of the Austrian central bank and the deputy director of the ECB suggested granting the ESM a banking licence which was seen as showing the way in which it would be legally possible to finance indebted countries while using the mechanisms exclusive to the ECB.   President Draghi went even further, saying plainly that he will do everything possible to save the common currency.  The market is looking purely  at short term liquidity and this can only be granted in unlimited quantities by the ECB.  But that will still not solve the basic question about the prospect of growth in Europe.  This is a problem that the ECB will definitely not manage to solve.  This is in the hands of politicians and will depend on their resolve in implementing  difficult supply-side reforms.

In Poland one gets the impression that for many decision makers, the broader perspective got overshadowed by Euro 2012.  Recent comments by some of our politicians make it sound as if they had only just realized that the economy really is slowing down.  Some confusion about statistics produced an unusually warm final quarter for 2011.   Moreover the economy was artificially stimulated by infrastructure spending which has now fallen off considerably.  This is also the cause of the problems in the construction sector where it is estimated that in two years’  time building demand could be met by a construction sector which is a third of its current capacity.   What counts most for the authorities however,  is that a slowdown in consumption and a feeble increase in investment have an adverse impact on budgetary inflows which not everyone had expected.  Most probably next year will be worse than this one which makes it crucial to amend the 2013 budget.  Poland should be more committed to the rescue of the european project because it does concern us.  The relationship between the Spanish and Polish economies is much greater than one might imagine.  Especially when it comes to trade via Germany.  Meanwhile last week Germany for the first time glimpsed the prospect of having their rating cut.  In Poland, when contemplating emergency measures,  it is not enough to focus on tax hikes and a reduction in investments.  We have to also have to examine spending and speed up privatisation.  In this the Elewar scandal should help.

 

We CAN (if we really want to)

  

How is it that when we truly desire something, we will climb mountains to achieve our goal and succeed, but if we tackle things with even just a little less determination, we get the same tired old results?

 

Let me go back to the fall of communism and its replacement with the free market model. What we managed to achieve in 1989 and 1990 will remain forever engraved in our collective memory as the perfect transition from a totalitarian system to democracy, followed by a perfect transition from a centrally planned to a free market economy. We don’t feel particularly proud of this, mainly because most of us consider the transition as a given but which still needs work. But back then nothing was a given – you only have to look to Ukraine for an example of an irresponsibly managed introduction of a democratic system and free market. The reason that the move succeeded was the iron clad determination of the ruling elite, an awareness that this was a huge opportunity with laser-like focus on the task at hand. The calibre of the decision makers was important.

 

While keeping a sense of proportion, we can say we have succeeded in doing that which a few years’ ago we would have feared would fail. Firstly there was the Polish presidency of the EU which was particularly successful. The presidency is not in itself a global scale event, but the ability to smoothly lead european affairs for six months is proof that when we want to, we can. Things did not go so smoothly for the Czechs or for the Hungarians. Another example is the European Football Championship. A wise man once said that one shouldn’t count chickens before they are hatched but it is already obvious that we are capable of organizing a massive event with decent infrastructure. Basically each of the founding EU members would consider the organizing of such an effect as almost routine whereas we still have to prove to the world and to ourselves that we are capable of doing that which passes for the norm in richer countries. The question is why can we not do something purely for ourselves, applying the same commitment and precision as we do in the case of any undertaking which will be judged by the outside world. I’m referring to such basic undertakings as a radical reform of the judiciary or of the state railway system. The kind of commitment we applied to Euro 2012 could be usefully reapplied for the introduction of all new solutions in the health sector where it’s not so much that the intended changes were bad but that their implementation was sloppy and not properly thought through.

 

In business, before any crucial decisions are taken, all the alternatives and possible outcomes should be carefully studied in order to preempt problems – still no guarantee of success – which is why risk should be kept to a minimum. This approach is sadly far too rare in the Polish public sector. The same can be said of the way laws transit through the Polish parliament. Frequently, when a proposed law gets to the parliamentary committee stage, that is when the proponent will start tabling amendments because he or she suddenly becomes aware of all the inaccuracies. It doesn’t have to be like that – this has been proved by the way Euro 2012 has been organised. The proposed organization of any undertaking, be it a football tournament or the Polish presidency should be sufficiently detailed and accurate and contain all the necessary checks and balances. In Poland, too frequently we concentrate on projects which lack an overarching conceptual strategy. The result is not just poor preparation but the necessity to adjust and amend in the final stages. This is all pretty obvious. Obvious, but frequently overlooked. We should remember that if necessary, we are capable of stepping up to the plate.

 

Greece – hard times ahead

The results of the Greek elections have been welcomed with a sigh of relief.  Obviously decision makers in Europe had a back up plan  which would have meant talks with the leader of the populist party Syriza – a difficult and unpredictable exercise.   Syriza had already announced street protests and renegotiating the bail out package.  However, it is unfortunate that the leaders of the victorious parties are not guaranteeing the responsible implementation of reforms.  For example only a few months’ ago, the New Democracy leader rejected the conditions of the bailout pact with Europe.  Moreover, he is even partially responsible for the current mess which was created by the irresponsible rule of the Greek establishment parties.  These parties, while somewhat more predictable than Syriza, are not pro reformer.  Whence the relief following the Sunday elections. 


There will be further rounds of talks.  Coalition political parties will have to work with representatives of the EU and of the IMF to find a way to drop demands for softening the bail out conditions  without saving face.  The plan cannot be radically changed because this might encourage radical movements in other countries to protest against already agreed austerity measures.  On the other hand the lack of any sort of concessions will simple add grist to the Syriza mill which will present itself as the only party capable of changing the bailout terms.  In one way or another Greece will continue to be on life support while struggling to implement reforms.   For the moment however there is no clear government coalition leader who would be capable of implementing the reform program decisively and quickly.   Greece needs to deregulate production, the labour market, privatisation – in other words to implement measures which will increase economic flexibility and competition.  If these changes are not implemented fast and decisively, the next few quarters will see a drop in wages along with continuing street protests.  Unfortunately this and the risk of early elections seems very likely.  

The spectre of a euro exit will be hanging over Athens for the next few years.  We shouldn’t assume that the federal Europe project within the confines of the eurozone will be capable of diminishing the risk which is political in nature rather than economic or institutional.  However, in the name of euro zone unity, Europe will do everything to prevent even the smallest country from leaving.  A Greek disorderly exit would be perceived by many as the beginning of the end of the euro zone.  It would be difficult to say why Greece should be an exception, as the financial markets would select the next countries which will have to walk the plank -  a huge defeat for Europe’s politicians who would be seen as incapable of halting disintegration.

To a great degree current tensions in southern Europe were caused by the lack of firm decision making two years’ ago.  In 2010 european leaders fiddled around with aid packages which subsequently turned out to be insufficient instead of quickly restructuring the debt and implementing a reform programme,  They also allowed Greek politicians to get into the habit of backing out of agreements and instead of immediately calling in the IMF with their tried and tested recovery programs, they went to the EU which is primarily a political body.   The longer this stalemate lasts, the more various countries will depend on each other and the more populist parties will try to hold everyone to ransom.  An example of this was last week’s announcement by the Syriza leader who said that the day Greece leaves the euro will be the day that the entire system will collapse.  Both sides are aware of the risk and are steering a difficult course.    After Sunday’s election result the ship finds itself in calmer waters but it will still be easy to rock the boat.

 

 

A Disorderly Exit

  

Things have got very serious.  Greek banks are haemorrhaging as withdrawals escalate and Switzerland has announced restrictions on money flows if Greece leaves the EZ.  In the United Kingdom there has been an increase in UK citizenship applications by Greeks who have been residing in the British Isles for over five years.  IMF chief Christine Lagarde showed her impatience with Greek politicians by saying that she is more concerned about the fate of children in Africa than that of Greeks struggling with the crisis and appealed to the Greek public to finally give up tax dodging.  Another EU summit took place, the end of which saw the release of fewer soothing comuniqués than usual.   It has generally been accepted that what has been agreed should prevail,  namely that no reforms equals no further financing.   Meanwhile in forex land, the euro fell to a record low agains the dollar, at 1.25.  In recent years the lowest rate was 1.20 dollars to the euro.  Caught in the flak once again are the so called emerging currencies – hence the drop in the value of the zloty vis a vis both the euro and the dollar.  The market has prepared for the worst case scenario, i.e. Greece leaves the euro whether it wants to or not.

 

The controlled exit option is unlikely because the approval of the Greek government would be required.  Even the most populist government will try to avoid this solution.  The disorderly exit is the most likely and would mean cutting off the country from external financing and the introduction of a new currency.  As I wrote last August :   "the disorderly exit option,  although unlikely,  is still possible.  Let us imagine a situation where one of the threatened countries in the EZ suspends implementation of the reform plan agreed with the  European Commission and the IMF. 

 

This would lead to the automatic freezing of liquidity which means it would no longer be possible to meet current financial obligations … A disorderly exit from the EZ is paradoxically easier and more likely than the orderly one.  A disorderly exit would require the flotation of a new currency together with the establishment of an exchange rate as well as the preparation of the necessary institutional infrastructure".

 

This is the threat which looms.  Centre stage is Greece and the party likely to suspend reforms is Syriza.  The flight of savings ratchets up the tension a couple of notches and could lead in no time to a run on the banks.  In order to prevent this the european monetary authorities must be ready at any moment to react.  This is undoubtedly the most real and urgent threat to the system.  The EU and its individual member states are preparing emergency plans in the case of a disorderly exit.  According to polls published recently in the Financial Times, the least prepared countries are those of central and eastern Europe.  Most probably because they consider that their direct connection with Greece is negligible and that in the majority of cases they have their own currencies and are less concerned with the euro’s problems than those who use it on a daily basis.  Nothing could be more misguided as a disorderly exit will lead to the kind of market panic which would dwarf even that seen after the collapse of Lehman.  All financial commitments would have to be converted to the new currency which in most cases would mean that creditors would not get paid.  And taking into consideration that the scale of interdependence is not fully known,  the only safe haven would be the ECB.  However in the case of not just Greek but unfortunately also Portuguese and Spanish businesses, there would be a total financial gridlock where everyone would fear a repeat of the Greek scenario.   This may even indirectly affect Polish businesses, not only because of the risk of devaluation but above all because of the paralysis of the european financial system.   Anyone who might be affected should have a plan B.  And the role of European and Greek leaders is to prevent things getting to that point. 

 

The Cause of Crisis is not Austerity but Lack of Firmness

  

The theme du jour is that Europe has had enough of austerity, that the cause of Greek woes is austerity and that the entire aspect of economic growth has been overlooked.  During the G8 in Washington at the weekend, Angela Merkel was under fire from the so called growth camp what with Germany being the prime example of a country whose economy is underpinned by savings.   Poor Angela, it is not enough that her electorate have had enough of financing the indebted countries of southern Europe, world leaders are increasing pressure on her to loosen fiscal measures and to soften her tone.  She has even agreed to eurobonds (which in effect would have to be underwritten by Germany).  Added to this is the electoral victory of Francois Hollande on the back of his "growth, not austerity" platform.  But is it really an alternative? 

 

It would be hard to find a leader who would be against growth.  How is it possible not to support something that everyone wants?  The problem is that you cannot just have growth by decree.  The politicians who most frequently advocate growth are really advocating the injection of public funds into the economy.  In particular President Obama seems to still believe that the slowly growing American economy may be momentarily kick started by public spending – in order to win the elections, but what then?  Today – a few years into the crisis – it is possible to see how a growth strategy based on public funds and government debt is both useless and hazardous.  Moreover,  such a strategy is unaffordable.   This begs the question: what should a growth oriented policy really look like at a time when most european countries are struggling with a heavy debt burden?

 

The strategy based on stimulating economic demand by increasing government spending has been around for the last thirty years.  However, if things were that simple, most countries would just throw public money at various enterprises and all the countries in the world would be flowing with milk and honey.  But public money has to come from somewhere, either from taxes or from debt, i.e. future taxes.  If this expenditure supports growth at the point of spending but does not create better conditions for future development, this money is wasted money.  And it is difficult to find investment projects in rich countries which ensure growth potential is generated at a time when the investment comes from public funds.

 

On the other hand, in countries which have lived high on the hog for years while being soothed by politicians uttering impossible promises, the public is little inclined to accept a decline in living standards.  And even if they do, as they did in Italy during the first few months of Premier Monti’s term in office,  they want to see the results of the reforms almost immediately.  Global experience in this area unequivocally demonstrates that the far reaching and swift application of reforms is better than a slow and drawn out system correction.  The Italian experience is interesting as during the first months of Monti’s term, the premier was able to achieve an increase in the retirement age without mass protests.  It is much harder now for the Italian government to implement further reforms as the honeymoon period is over and the public have decreed that they’ve had enough of reforms against the backdrop of decreasing market pressure.  In the face of Greek chaos, markets can again speed up crucial reforms both in Italy and in other countries of southern Europe.  Spain is an example of what happens when reforms are delayed, where the irresponsible application of crucial system changes, in particular the sidelining of the in depth restructuring of the banks has led to a situation where today Spain has joined Portugal in being a candidate for possible debt restructuring.

 

The cause of the problems of southern Europe, in particular those of Greece, is not the overly harsh reforms but their opposite – a sloppy and inefficient application of said reforms.  In Greece in particular shock therapy was and still is the answer.  If they do not apply this, then the markets will do it for them. 

Without EU financing, they will have to introduce a new currency side by side with the euro and this will be devalued right out of the gate which will lead to the country’s drastic impoverishment.  Such an alternative is much worse than focussed austerity measures.