Wednesday, 2 November 2011

Euro crisis requires local solution, not global one. Guest post by Saumitra Chaudhuri

Saumitra Chaudhuri, for friends Chow, member of India's Planning Commission, rejects the idea of BRIC leverage for the EFSF, in The Economic Times, 31 October 2011, as usual in a wonderful English prose.

“Bloviation” is a style and term invented in Ohio, USA, made well-known by its usage as political speech by President Warren G. Harding and formally recognised as a uniquely empty form of expression by the great journalist and critic H.L. Mencken. It is ironic that this term bloviate, with its common Yankee origin, is the appropriate one to describe the proceedings at Europe’s numerous summits on their crisis of debt.

Last week, Europe’s leaders apparently found a solution to resolve their crisis. It comprised of (a) forcing banks to accept a haircut of up to 50% on Greek debt, (b) enlarging the European Financial Stability Facility (EFSF) war-chest from €440 billion to €1 trillion, (c) requiring European banks to find more capital against their losses on Greek debt and (d) making a phone call to China’s President Hu Jintao. The euphoria lasted all of a day-and-a-half.

How a decision taken at a summit of heads of state/govt. that banks will write-off 50% of Greek debt can be said to be “voluntary” boggles the mind. All defaults lead to loan work-outs and the easier end of it, is deferment (restructuring), the harder part of it, is partial write-offs. So, it would be correct to conclude that all of what happened recently was a post-default loan work-out. Insisting that it is not a default only undermines the credibility of the arrangement and leads to the kind of avoidable jitters that were created when part of the non-European financial world used the “d” term – default – to describe what happened. Rather reminiscent of the power wielded by Europe’s heroes of myth over dragons – their true name.

The EFSF is now supposed to insure up to 20% of losses that may arise from banks purchase of other sovereigns bonds – perhaps of Italy, Spain and Portugal – though that is not clear. There was talk of leveraging this €1 trillion fund up to 4 to 5 times by a mechanism that is unclear. Of course, all participating nations whose sovereign debt may result in losses and who are therefore being insured by other sovereigns are in prospective default. How tiresome.

Next, European banks will need to raise more capital for the losses they have taken and will have to continue to take. Are investors queuing up to contribute to the losses that these banks will have to incur as future summits will determine? Unlikely, except in a fantasy world: One peopled by rich Arab sheikhs and Chinese central bankers, with over-flowing pockets and empty brains. Which brings us to the phone call to President Hu Jintao.

China has $3.2 trillion in foreign currency assets. Surely they would not miss a trillion or half. Especially if wooed by the proverbial European, or rather French, elegance and charm. Surely something could be arranged on a scale grander and more magnificent than the Chinese section in the Galeries Lafayette. China must take its high seat in the “save-the-world” elite club. Europe needs to be saved and that is going to cost money and for that pressing need of realpolitik, the normal requirements of fine breeding and decorum may be dispensed with. Perhaps the status of “market economy” can be granted, like a latter day noble genealogy, may be more votes at the IMF.

In China, there are apparently two views. One, the minority one (or so I understand) reflecting the interests of the exporters of consumer goods is thus. Yes, the Middle Kingdom must step in, to save the Europeans who otherwise will not save themselves and thus doom our exports. Data for Jan–July 2011 suggests that this works out to annualized export value from China of €210 billion to the Euro-zone and €280 billion to the larger European Union. Or look at this way: of Chinese trade surpluses of €100 billion and €150 billion respectively.

Second, is the majority view (as I understand) that it is Europe that must in essence save itself. Which, it is not doing by refusing to accept the facts. As Deng Xiaoping had once written, the “quintessence of Mao Zedong Thought” is expressed in the four words "Seek truth from facts" – a slogan that Mao had coined in Yan’an.

The fact is that the European Monetary Union was not a good idea. It sprang forth whole from the minds of grand theorists of the European dream – one uncontaminated by petty national identities, befitting of the high minds that guide the helm of European decision-making – Olympian, in its majesty and in its self-esteem.

Greece and countries that were in the other lane vis-à-vis northern Europe should have been allowed out of the Euro-zone. That is what eventually is anyway likely to happen. Greece would have devalued. German and French banks holding Greek bonds would have taken losses Рas indeed they are taking today. Greek banks however would have remained whole and functional Рwhich they are not today, bankrupted by their holdings of the euro-bonds of their own sovereign. The Greek economy would have suffered from compressive effects of the large depreciation, but that they are anyway suffering. At least they would have a functional banking system left.

But such a decision would have forced Europe’s leaders to face the facts and adapt – which they choose not to do. Surely, not just China but the rest of the world will be sought to be drafted into the “save-the-world-by-saving-Europe” platform at the G20 summit. It was absurd making Slovakia with a per capita GDP of $16,000 bailout Greece with a per capita GDP of $27,000. It is preposterous to expect that China with a per capita GDP of $5,000 or India with one of $1,500 should bail out Greece and its even richer colleagues.

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