Monday, 25 March 2013


There is a tendency, whenever a euro zone country gets in to difficulty, and needs help from its neighbours, to blame Germany for the severity of the terms imposed, and to say there is bullying involved.

In both Greece and Cyprus, we hear references to the Second World War, as if offering Greece a low interest loan to keep its state functioning , was equivalent to a military invasion, of the kind Greece experienced in 1941.
There is also talk of  the “solidarity” that Germans ”owe” the rest of the rest of the euro zone, even though  any money Germany might pay has to be raised from German citizens, under the German tax system. This is the way it has to be done, only because there is no common euro zone tax system, applicable to all euro zone citizens, from which the money might otherwise come. Indeed those who call most loudly for “solidarity” would probably be the first to object, if a common euro zone tax system, equally applicable to all euro zone citizens, was proposed.
Others criticise Germany for insisting  on “austerity” in spending by countries that are spending more than they are earning, as if there was some alternative to spending less in those circumstances. The fact is that some countries, including Ireland, are still spending more than they collect in taxation, even after one has left out of account the interest paid on past debts. Such countries have what is called a “primary deficit”.

Ireland had a huge primary deficit in 2010, has a small one today, and hopefully will have a tiny primary surplus next year. 

But if it is  to reduce its debts, and  thus not be vulnerable to disaster, if there was to be a sudden increase in international interest rates, of the kind that occurred in 1979/80, Ireland will have to have a primary surplus for many years to come.

That is the only way to reduce the debts it ran up through the primary deficits it ran in the recent past. This is not something “imposed by the Germans”, it is imposed by the rules of mathematics, and by compound interest in particular.
Of course there is one alternative-inflation-  the alternative of inflating debts away. Inflation devalues everything. It reduces the value of money, and in so doing, it also reduces the value of debts.......and, of course, of savings.

If inflation is greater than the rate of interest, debts will reduce. But the value of pension funds, of bank deposits and of life assurance policies would also reduce. Inflation would mean falling living standards all around, because, if a country is to stay competitive, wages would have to increase at a slower rate than prices. Those on fixed incomes would see their living standards decline even more, because they could buy much less each year with their fixed income.

Inflation is very hard to keep under control, once it starts to take hold. Germany tried to inflate away its First World War debts in the 1920s, and the experience was a complete disaster. Understandably, it does not see inflation as a solution to Europe’s debt problems today, and nor should we. 
Some argue that Germans themselves should spend more and save less, and say this would help other countries in Europe. This is already happening to some extent . German imports were 10% higher in 2011, than they were before the recession, whereas almost every other European country is importing less now that it was then.   It is fair to say that Germany’s balance of payments surplus, at 6% of GDP, is very high indeed, too high, and that this surplus is not being used all that wisely. Germany could do more to free up its own internal market, and the OECD has been critical of it on that score, but that offers a long term, rather than a short term, solution for the rest of Europe.
It is also important to deal with the myth than Germany is a terribly wealthy country, that it can afford to bail everyone else out.

Germany’s present competitiveness is of recent origin. A dozen years ago it was the “sick man” of the European economy, struggling with the unexpectedly high costs of absorbing East Germany. 
Germany got a big bonus from the opening up of China, which imports a lot of German engineering goods, while other European countries( eg.Italy) have lost for the  same reason, because Chinese consumer goods are undercutting them in their specialist markets.
Germany is an elderly country, with far more people approaching retirement age than are preparing to enter the work force. 
Probably for this reason, its medium term growth potential, and thus its medium term debt repayment potential, is low, by comparison with other countries in Europe. 
The OECD did an estimate of real growth potential for different countries from 2016 to 2025. Its estimate for Germany was  only 1.2% pa over the ten year period, for Netherlands 1.4%, for Italy 1.5%, for Portugal 2.1%, for Spain 2.3%, and for Ireland  it  was projected to be 2.7% a year!
German families are apprehensive about the future, and if those OECD figures are to be believed, it is hard to blame them.
German families do not FEEL wealthy.

Only 44% of Germans own their own home, as against 58% of French people, 69% of Italians, and 83% of Spaniards. According to a recent Bundesbank study, the average household wealth in Germany is  195,000 euros, as against 229,000 euros in France, and  285,000 in Spain.

This is the reality with which German politicians have to cope.

It does not mean that they are always right, but it does mean that they have to be cautious. It also means that Germany alone cannot solve Europe’s  financial problems.

Tuesday, 19 March 2013


All resolutions of banking crises involve imposing and sharing sacrifices. 
As far as possible, people should know in advance how sacrifices are to be shared.

No way of saving is completely risk free, but the greater the risk, the greater should be the reward and vice versa. A high yield bond should be riskier than a low interest deposit.

It is on this basis that the terms of the proposed bailout of the Cypriot banking system should be scrutinised, because it illustrates how Euro Zone policy makers are thinking.
The initially proposed bailout of Cypriot banks involved imposing haircuts of the depositors in Cypriot banks who have been covered by the deposit guarantee scheme, that is depositors with amounts less than 100000 euros. Whose idea was this?

Setting aside the terms of a deposit guarantee like this would be a very serious step for Euro zone policy makers to have taken.  It calls into question the integrity of deposit guarantees generally. That is hardly a good idea when we a trying to restore confidence in banks and rebuild their capital bases


According to today’s Wall Street Journal, an alternative to burning the  guaranteed depositors, was proposed by the IMF. 

This was 

“radically shrinking the two largest banks, including bailing in senior bondholders, and letting deposit insurance  kick in. In that case, depositors in Laiki Bank and Bank of Cyprus would have faced losses of 30 to 40% above the insured 100000 euros.”

It would appear therefore that an explicit legal guarantee of deposits is to be set aside so that senior bondholders and unguaranteed deposits are to have reduced, or in the case of senior bondholders, no, haircuts.

The net effect of this is that a deposit guaranteed euro in a Cypriot bank is not worth the same as a euro in a bank somewhere else in the euro zone. This is contrary to the underlying principle of having a single currency. 
The philosophy behind the decision to afford protection to the position of the, admittedly small number of, senior bondholders of Cypriot banks, at the expense of guaranteed depositors, has yet to be explained.
 Senior bondholders are commercially well informed investors, depositors are not. Senior bondholders also earn a better interest rate than small depositors do.


It is also hard to understand why it was EU policy to impose a haircut on the senior bondholders of the sovereign Greek state a few months ago, but not now  to impose a haircut on the senior bondholders of private Cypriot banks, when that was suggested by the IMF.

Indeed, part of the problem of Cypriot banks , is that they were themselves senior bondholders of the Greek state, who suffered a haircut on those bonds as part of the terms of the Greek bailout. 

Who are the senior bondholders of Cypriot banks who are so deserving of 100% protection? Who are the big depositors whose haircuts were to be reduced by attacking the, sub 100000 euro, guaranteed depositors?
A credible and consistent banking system is essential to modern economy.

The EU is committed to establishing a banking union, including a single system for winding up banks and guaranteeing deposits.

The precedents being set in the Cypriot case are important, and, my personal view, troubling. They do not indicate clarity or consistency of thought by either the euro zone Finance Ministers, or the European Commission. The rejection of the deal by the Cypriot Parliament now gives Euro zone policymakers a chance to think again about the underlying philosophy of their approach to the financial crisis.

Wednesday, 13 March 2013


I am in the United States this week on a “road show” promoting the Irish Funds industry.
This is one of the biggest components of the international financial services industry in Ireland, and it  employs about 11,000 people, in well paid and highly skilled jobs.

Large numbers of Irish Fund promoters, lawyers, and accountants are taking part in the road show which is taking in Chicago, Boston, New York and California. 53% of the resources managed or administered by funds in Ireland  originate in the United States .

The Irish Funds industry operates under EU rules, which are in a process of constant evolution, and a  big part of the activity in the road show consists in  explaining the latest EU legal developments.

EU rules have the merit that, once complied with, the allow an approved fund to do business throughout the entire EU and in other jurisdictions which apply the EU rules.

Ireland has a number of key strengths as a location for the international funds industry.

One is the  depth of expertise available in Ireland in professional firms.

Another is a sophisticated and accessible regulator, in the Irish Central Bank.

A third one is the availability of highly motivated staff, at moderate salaries, in an English speaking country, with easy transport links.

Wednesday, 6 March 2013


The news that separate buses, on the same scheduled routes, are being introduced for Israeli settlers and for Palestinians in the West Bank has disquieting precedents.

The fight against segregation on the same buses in the American South was a key part of the Civil Rights campaign there. Segregation in transport also featured in South Africa in the past.
The West Bank has now been occupied, and governed, by Israel for 46 years now.  That is for most of the time that Israel itself has existed.
The Palestinian residents of the West Bank have no vote for the Parliament which makes the important decisions as to what happens in the area in which they live.

Israel is the only functioning democracy, apart from Turkey, in the region, but its democratic privileges do not extend to the Palestinians it governs in the West Bank.
West Bank Palestinians have been encouraged to pursue the goal of a Palestinian state in the West Bank, but the physical space that such a state might occupy is being increasingly taken up by Israeli settlements and infrastructure.
I wonder if the West Bank Palestinians might not be wiser to change the terms of the debate on its head and  seek 

  • ”one person one vote”, and equal privileges, and
  • the incorporation, on that basis, of the West Bank into Israel.

Given the history and ideology of Civil Rights in the US, it would be difficult for the US to decline to support such a demand. It would also require Israel to ask itself the hard questions about its long term intentions for the Palestinian people it governs on the West Bank. For its own sake, Israel needs to ask itself these questions sooner or later.