More or less what was expected. €85 billion at 5.8% interest. €10 billion in immediate cash to re-capitalize the banks, another €25 billion line of credit for the banks, and €50 billion to meet state budgetary needs. Oddly, the Irish government must contribute €17.5 billion, mostly from the state pension system.
Most interestingly, a vague “permanent resolution mechanism” for restructuring debt was announced that will go into effect sometime in 2013, and that “may” require bondholders to take losses at that point. That’s their long term solution to the contagion problem? Wow.
It seems that a number of blogs have picked up on Belgium as a likely candidate for the next domino to fall – either immediately before or immediately after Portugal.
Let’s look at the facts here:
- Belgium’s budget deficit is under 5% of GDP, below the Eurozone average
- Belgium has a savings rate of 11.5%
- Belgium is currently running a current account surplus, and has been for some time
- Belgian GDP is growing around 2% per year
- Belgian 10 yr bonds are trading at roughly 1% above German Bunds, a mere fraction of the spreads at which other Eurozone countries’ bonds are trading
So what is the case for a Belgian default?
It seems to be:
- Belgian national debt is around 100% of GDP, third overall in the Eurozone, behind Greece and Italy
- Belgium has failed to form a new government for the past 6 months, with a split between parties representing the Dutch and French speaking areas
- Concerns over Belgian banks, which in reality are no shakier than those of other Eurpoean countries not consider to be on the domino list, certainly far less shaky than those of Ireland
National debt as a % of GDP is not an indicator of short term instability. It’s only real relevance is with regard to debt service levels, and given Belgium’s current account surplus, savings rate, and GDP growth, this is a non-issue in the short to medium term. The danger represented by lack of a government is completely overblown, and if there were a crisis, I’m fairly confident they’d pull together a government in short order. The banks, again, really are in no more of a fragile state than those in the rest of Europe.
If, in fact, a “crisis” does develop in Belgium, I think it warrants stepping back and re-examining what’s really happening in Europe and whether the current approach to rectifying the problem is appropriate.
Assume you are a neutral observer, behind a sort of Rawlsian Veil of Ignorance, tasked with examining an unknown country’s economic situation and making policy recommendations.
The facts are: 20% unemployment rate, 0% GDP growth, inflation at just over 2%, and a budget deficit of 2.96% of GDP and down significantly from a year ago.
Would anyone in their right mind recommend further austerity, e.g., spending cuts and tax increases, given this set of facts?
In 2007, Ireland ran a budget surplus of 0.051% of GDP. That was the 5th straight annual budget surplus for Ireland. In fact, from 1997-2007, Ireland ran an average 1.6% annual budget surplus. Likewise, in 2007, Ireland’s total government debt was 25% of GDP. This was not a country on the brink of a fiscal crisis.
Fast forward to the present.
Ireland is now running an annual budget deficit of around 32% of GDP and the national debt is 65.6% of GDP.
What happened? Obviously the financial crisis led to a large falloff in tax revenue, along with an increase in countercyclical spending. That’s not the main story, however. What really happened is that Ireland experienced a banking crisis and the Irish government guaranteed its banks. That is the prime driver behind the numbers and is the motivating factor behind the ongoing bailout talks.
Ireland is about to inflict an unconscionable amount of pain on its citizens through a combination of austerity programs while saddling them with an enormous amount of new debt in the form of the EU/IMF bailout. Is this necessary? This amounts to a naked transfer of wealth from ordinary Irish citizens to a handful of German, British, and French banks who are creditors of the failed Irish banks. There’s no making the losses disappear, the only question is who realizes them. It has been determined that the Irish government, and by extension, the citizens of Ireland, will realize the loss. Why? Why not the bondholders?
Post-WWII (1946-2009) Average Federal Gov’t Spending and Receipts as a % of GDP:
There were no significant tax policy changes between 2007 and 2009. Nor were there any major spending policy changes apart from those incurred due to the financial and economic crisis.
The long-term historical budget gap has averaged around 1.8-1.9% of GDP. Immediately prior to the crisis, it was right around, if not slightly below, the long term average.
The current budget gap of around 10% of GDP is due almost entirely to the financial crisis which caused a falloff in GDP (and thus, tax receipts) and the need for temporary emergency spending. Eventually, receipts will rise and spending will fall as a result of pickup in GDP and the winding down of temporary emergency programs even if we take no deliberate action. Adopting austerity measures to try and prematurely bring down spending and increase receipts will likely have the opposite effect.
There has been no significant increase in the “structural deficit” over the past 3 years. While the Bush tax cuts and the 2 wars we’re fighting have obviously played some role in our budgetary position, they’re not the major drivers. Democrats who say otherwise are lying. Likewise, Obama hasn’t done anything to increase the structural deficit either. Republicans who say otherwise are lying. The entire “deficit crisis” meme is nonsense. Long term, we do need to get Medicare costs (and healthcare costs in general) under control; short term, the focus needs to be 100% on economic growth and jobs, even if that means bigger deficits.
I’ll focus here on what I call “compositional effects” – how the composition of an action (in this case QE) can be more important than the absolute level of the action.
Bernanke has used the metaphor of “dropping money from a helicopter” in past discussions of monetary policy. The implication is that the Fed could always prevent a deflationary spiral through the use of their “printing press”. Let’s look at compositional effects as they apply to the helicopter metaphor. In this case, what matters is who receives the newly created money, or, to extend the metaphor, the location of the helicopter when the drop begins. Consider for a moment that the banking system is currently sitting on around $1 Trillion in excess reserves and the helicopter drop will simply funnel an additional $75 billion or so per month to these same banks. Bernanke has effectively positioned the helicopter over a volcano before starting the drop. When the drop is done, we’ll likely have $1.6 Trillion in excess reserves with very little net change in the real economy. Perhaps a smaller drop, with the helicopter instead positioned over Main Street would have been a wiser move.
Now let’s look at QE and inflation expectation through the lens of compositional effects. Changes in inflation expectations have been put forward by numerous economists, including Paul Krugman, as the primary mechanism through which QE will stimulate the economy. This makes sense if price level changes, or rather the expectation of future price level changes, are more or less homogenous throughout the economy. What happens if they are not? What happens if the primary effect of QE is to increase the prices of commodities (oil, food, metals, etc.) but not finished goods or labor? This would result in a sort of reverse wealth effect for individuals (who could now consume less energy and food out of a constant income) and declining profitability for firms (who face rising input costs and constant output prices). The net effect would be a decline in aggregate demand. Compositional effects matter.
FOMC Press Release:
To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.
$600 billion in longer-term Treasuries at a rate of around $75 billion per month. This is roughly in line with expectations (consensus was for $500 billion – $1 trillion, at a rate of around $100 billion per month), though it’s at the lower end of the range. Also, there had been talk about the Fed potentially purchasing MBS and other assets in addition to or instead of Treasuries and that did not materialize.
I’ll post more later.