a fist full of billions

So the EU finally tried to get "ahead of the curve", and announced the mother of all bailouts -- a cool 750 bn € or so, but who is counting? Speculators, so the official line, caused the markets for sovereign debt to be dysfunctional. That is why the EU offered massive credit lines to Southern Europe, and the ECB is now buying bonds by sovereigns whose debt wasn't worth a great deal a week ago. As a quid pro quo, the countries in question - Spain, Greece, Portugal - are making a big show of tightening their belts, including wage cuts for civil servants, etc. What do we make of this?

The first thing to note is the German reaction. It is a little hard to communicate to people who only speak English that the poor, naive Klutzes in former Deutschmarkland actually believed in the "rules" -- no bailouts, the Euro as stable as the DM, etc. The FT was recently making fun of Germans being a little literal-minded. That may be true, but is hard to overstate the consequences of last week's events. In the minds of many Germans, this is the beginning of the end of the Euro, nothing less. It is not what they were promised, it was a lousy deal in which they gave up something they cherished - the DM - for little more than empty promises of budgetary probity and worthless paper bonds. The idea that there is "no alternative" (Merkel's pitch to the German public re the bailout) is not convincing anyone. I expect that some parties are going to try and make hay of this, or that the constitutional court will actually declare the bailout package illegal.

The arch-conservative FAZ, a daily newspaper that is as close to the CDU as the Times of old used to be to the Queen, just published a fictitious retrospective about the demise of the Euro, with 2010 as the turning point. Their idea - it won't take beyond 2013 to get there. Is it going to happen? Nobody can be sure, but I would say that the probability of an exit of Greece, Spain, Portugal, Italy has gone from 2% to 20% within the next 10 years within a week. Current austerity measures will make the recessions there much more painful; and before long, governments will be tired of budget cuts, strikes, and general unhappiness. The Great Depression ended when countries cut the link with gold, and the earlier they did it, the better they fared. The same will be true -- getting out of the Euro will be a god-sent for these countries, provided they can escape with their banking systems intact.

The Mother of All Bailouts

I was just in Rome for a talk at Ente Einaudi (and some plain old tourism, enjoying Richard Meier's Ara Pacis Museum) when German TV asked me to comment on the mother of all bailouts and latest perturbations of the current sovereign debt crises. For German speakers, the link is here. I am trying to say nice things about speculators, and at the same time think we have to get serious about bank reform. They didn't ask me about the rescue package, which in scope and motivation seems singularly misguided. They do want to know about what to do, and I emphasize the need for financial sector regulation. How often do we want to live with this type of blackmail, where the financial sector asks for a bailout because otherwise, the rest of the economy might suffer.

Times of distress also create a demand for cranky ideas. The Germans from 3SAT found a "visionary" in Vienna that wants to replace the Euro with the Globo -- a single global currency. I think it's a spectacularly stupid idea, and if there is something stunning about it, it's that this kind of idea is given an airing at all. But hey, people discussed Federgeld at some point, money that would lose its value if not used in transactions -- a way to tax "dead capital". The party that pushed it? Just a bunch of freaks, on the very fringe, with no chance to enter office... until they did, in Berlin in January 1933.

Me? Worried? About Spanish banks?

My bank in Spain has recently been unusually friendly and generous. Normally, they are happy to pay me 0% interest for the balances I keep. Now, as I was asking for a routine transfer to my other account in Germany, I got a phone call - and a bit of a surprise. How about, said the friendly branch manager, 4% if you keep it here? No? How about 4.5%? No? Did the Germans offer more? What can we do to keep it? Shall we meet in person? Wow. I am so friendly with my local branch, I have actually never met my branch manager. So this was starting to sound a bit funny. I don't keep balances the withdrawal of which will threaten the survival of this bank (or any other) single-handedly, so this particular, keen advisor got me worried... but checking a bit, it seems to be a general thing. Spanish banks are effectively finding it very hard to borrow in wholesale markets; private banking clients are pulling their money out bigtime, and putting it into stable core countries; and every bank and caja is now offering 4% term deposits, which is a pretty amazing rate given that Euribor is just a touch over 1%. Now Moody's has published a small note on contagion risk from the Greek crisis for Spanish and Portuguese banks. Given that they are rapidly becoming real estate investment trusts with a banking business attached, trying to sell millions of repossessed homes, there were plenty of fundamental problems to worry about. Now, we have something similar to a bank run in the bond issuance building up. Actually, while I have no particularly insight into how the balance sheets of Spanish banks look, I think I'd rather be safe than sorry, and send a bit more dough back home...

Too much...

...going on these days. Last week, we had Mike Woodford (Columbia), who talked about how we can make sense of what the Fed (and many other central banks) were doing by tweaking their balance sheets and buying financial sector assets. It's actually surprisingly hard to break the equivalent of the "nothing matters" equivalent of Modigliani-Miller theorem. Mike gets there by a combination of the banking system doing funny things (sometimes worrying too much or too little about credit risk), and massive heterogeneity amongst agents. It all adds up in a Neo-Keynesian model... and amazingly, it was all done without anyone having worked it out beforehand. What was the old Keynes comment about policymakers being beholden by a defunct economist? Here, it worked the other way around, with practitioners going first, and theory following.

This weekend, we had a CREI-CEPR conference on the Political Economy of Economic Development. Held in the beautiful monastery in Manresa, there was an embarrassment of intellectural riches, with Tim Besley speaking on the emergence of state capacity, Jim Robinson presenting joint work with Daron Acemoglu about the monopoly of violence in Venezuela, and a whole host of other interesting papers (from local elite capture in China to war and genetic relatedness).

At the same time, we had news about the biggest bailout in history being finalized. After a mini-bounce this morning, Greek bonds have started to trade lower... it seems that the last few weeks of flip-flopping have unnerved investors a great deal. I wrote some months back that the game was entirely political - that the economics were hopeless, and that only a political decision to make Greece whole could stave off default. It seems that markets came around to that view, and now find it hard to believe that the political solution is at hand. As exercises in "shock and awe" go, this one is as yet not very successful...