Citizen Economists » EU

The perils of European debt crisis: divergence, retreat or decline?

Rok Spruk — Mon, 16 Jan 2012 12:20:26 +0000

Recent debacle at the summit of Brussels in the midst of the political intervention of the EU leaders to facilitate the institutional agreement between the European countries towards the formation of the European fiscal union has caused not only a long-standing dissolution of the “core countries” of the Eurozone and the UK but, more importantly, a non-solvable puzzle on the end scenario of the European debt crisis that pervaded both the eurozone and the countries outside it ever since the beginning of the 2008/2009 financial crisis. The anatomy of the European debt crisis is a multifaceted process that is heavily interrelated with the economic principles of the process of European integration and the unintended consequences that erupted in the recent debt crisis.

The introduction of Maastricht criteria that stipulated fiscal prudence by obliging EU member states to adhere to the level of public debt below 60 percent of the GDP and low fiscal deficit boosted the expectations of stable macroeconomic environment, partly sustained by the European Central Bank which, since its inception in 1999, successfully maintained price stability. Despite an enviable achievement in the stabilization of inflation expectations, the EU Treaty did not stipulate stringent fiscal rules in case of the breach of treaty obligations on behalf of EU member states, neither has European Growth and Stability Pact (EGSP) provided selective mechanisms that would hinge on the EU member state in case Maastricht criteria were not fulfilled. On the other hand, the gradual enlargement of the European union did not finalize in the economic union characterized by the realization of four basic freedoms.

In 1977, Portugal and Spain were acceded into the European Union. Four years late, Greece was admitted as the 12th member of the European community. Over time, the EU grew from an integrated area of 15 Western European countries into a conglomerate of nations that did not impinge of the full-fledged liberalization of the internal market in 1988 but, moreover, has evolved into the spiral that accelerated the community toward the political union. In the mean time, member states of the Eurozone have continuously breached the rules laid out by Maastricht treaty. In bearing the fiscal consequences of the reunification, Germany repeatedly breached the Maastricht criteria both in public debt and fiscal deficit which postponed the introduction of the Euro, following a large shock from gigantic fiscal transfers from high-income West Germany into low-income East German regions. In a similar manner, until 2005, France did not manage to reduce the debt-to-GDP ratio under the 60 percent threshold stipulated by the Maastricht criteria.

Nevertheless, peripheral countries such as Spain and Portugal entered the Eurozone at an overvalued exchange rate relative to German mark before the introduction of the common currency. In the following years, these countries, notably Spain, accumulated significant current account surpluses resulted from the inflows of direct investment from the core countries such as Germany and France. These surpluses were, of course, artificial in the sense that the downward convergence of interest rates in the peripheral countries stimulated the over-leveraging of the financial sector which triggered a balloon in the housing sector.

For years, Italy and Greece have repeatedly breached the Maastricht treaty in the fiscal sense. Prior to adjoining the European Monetary Union, Greece repeatedly experienced volatile inflation rates and default on its external obligations and subsequent Drachma depreciation. Italy’s macroeconomic stabilization hinged on the discretion of government spending which, after excessive rises under various transition governments, cumulated in one of the highest debt ratios within the EMU. How could EMU countries, despite a stringent set of rules delineated by the Treaty of Maastricht, pursued discretionary fiscal policies and jeopardized the macroeconomic stability of the national economies and the Eurozone?

Prior to the onset of the financial crisis by the end of 2007, little was known on the perils of excessively leveraged balance sheets which investment banks used to seek high rates of return on high-yield and relatively risky peripheral regions. Until 2007, the exposure of major German investment to over-leveraged financial sector in countries such as Spain and Greece generated sizeable spillover effect. Before the onset of the financial crisis, Spain enjoyed sizeable current account deficit resulted from excessively high and robust overall investment. In 2007, Spain’s investment-to-GDP ratio (31 percent) was roughly comparable to developing Asia. In such highly volatile environment where economic growth departed from its long-run fundamentals, even small-scale macroeconomic shocks can result in a substantial loss of economic activity, notwithstanding the spillovers in the banking system and labor market.

The asymmetry in political structures and underlying macroeconomic fundamentals across member countries casts significant doubt in the long-term stability of the Eurozone as an area with common monetary policy. The necessary condition for the inception of common monetary policy does not hinge on the political initiatives that pervaded the process of European integration but on the careful consideration whether adjoining countries adhere to the macroeconomic criteria as denoted by the Maastricht Treaty. The failure to adhere to the contours of fiscal prudence and budgetary discipline by the major EU member states, with few notable exceptions such as the Netherlands, Austria and Finland, lies at heart of the underlying reasons why significant asymmetry and non-coordination in fiscal policy resulted in the adoption of dispersed economic policies whereas the adverse outcomes were not foreseen neither by the politicians neither by policy advisers and academics.

To a large extent, as the recent debt crisis has succinctly demonstrated, the ultimate goal of the European monetary integration was the build-up of political union. But whereas European politicians were preoccupied with all-embracing design of the EU as unitary political union, they forgot to acknowledge that political union would require the full convergence of economic policies including the integration of the labor market which hardly any political initiative within the EU deemed feasible.

The non-coordination of fiscal policymakers was highly evident in the division of member states on the core countries and EU periphery. Considering the peripherical countries, Italy, Spain, Portugal and Greece repeatedly proved ill-disciplined in managing the levels of public debt and the magnitude of the budgetary imbalance. Portugal is often the case in point. Prior to the introduction of the Euro, Portugal experienced unprecedented economic boom. Between 1995 and 2001, economic growth averaged 4 percent per annum and the unemployment rate reduced from 7 percent to 4 percent by the end of 2001.

At the same time, nominal wages grew rapidly without the necessary productivity growth compensating for the increase unit labor cost. Alongside the overheating of economic activity, driven by construction boom, current account deficits increased significantly, lowering domestic savings rate. After the country experienced a mild recession in 2003 when domestic output decreased by 1 percent on the annual basis, the slowing of artificial economic growth driven by the Euro boom, turned from temporary into permanent. In the period 2002-2010, growth of domestic output averaged at the level of no more than 1 percent per annum with stagnating productivity and significant pressure on nominal wages. Since the size of the labor cost is the major deterrent on growth, the cure for Portuguese ailing economy is the structural adjustment in the public sector such as the reduction of public debt by generating substantial primary fiscal surpluses and the lowering of government spending. Similarly, the experience of Greece, Spain and Italy suggests the evolution of the same pattern evolving over time although Italy has been known as low-growing economy during the boom time.

However, fiscal policymakers in peripheral countries repeatedly produced ill-conceived fiscal mismanagement of public finances. In 2008, the level of budgetary deficit in Greece exceeded 13 percent of the GDP whereas the country has not adhered to Maastricht criteria ever since the introduction of the Euro. After the depreciation, the net debt as percent of GDP in Greece reached 85 percent of GDP and increased to 110 percent of GDP by the end of 2008. As IMF’s recent forecasts suggest, by 2012, Greece’s public net debt could reach 175 percent of GDP.

The failure to adhere to the common set of principles as delegated by the Maastricht treaty and EU Stability and Growth Pact in the peripheral countries stemmed largely from the mismanagement of public finances and structural rigidity of the public sector with resulting increases in the burden of the labor cost. In addition, the adoption of extraordinary measures embedded in the public sector such as very low effective retirement age and substantial bonuses for civil servants exacerbated the burden of the public debt with unforeseen net financial liabilities of governments which have not mitigated the persistent burden of public debt that grew substantially over time in the EU periphery.

A natural question is whether the exclusion of peripheral countries from the Eurozone might be feasible and whether Greece’s default on external obligations might help overcome country’s mountainous strain on public debt. First, the re-adoption of domestic currencies is hardly a solution to overcome the intricacies of debt crisis. If Greece re-introduced drachma, external obligations would be strained by a painful and enduring bank run since investors would withdraw the deposits from the portfolio and invest it into safer holding with less volatility and uncertainty ahead. Another argument in favor of Greece exiting the Eurozone is that a devaluation of drachma would boost inflationary expectations and consequently reduce the burden of the public debt but given junk score on government bonds, a rather immediate bank run would follow the devaluation of drachma rather than macroeconomic stabilization.

In addition, when Greece’s domestic output is growing far below the long-term potential, inflationary expectations is not a feasible tool to revive the economy from deflationary trap with 16 percent unemployment Moreover, the only feasible and meaningful short-term strategy to boost growth is the reduction of the size of the public sector including the privatization of inefficient state-owned enterprises to generate substantial fiscal surpluses since this is the only plausible measure to tackle the increasing burden of the public debt. As the history of financial crises suggests, the eruptions of banking crises occurred mostly when governments rested on currency devaluations as the ultimate tool to reduce the burden of external debt. In addition, if Greece defaulted on its external obligations, CDS spreads could indicate a snowball effect where Spain, Portugal and possibly Italy could follow the same track.

The question is whether non-coordination between European fiscal policies helped facilitate over-leveraged financial sectors which asked for the bailout by central governments in the wake of the 2008/2009 financial crisis. Over-leveraged financial sectors were attributed to the determinants of various extent. Some argued that over-leveraging is the outcome of innovative financial engineering where fancy mathematicians and physicists applied VaR models to calculate the probability of losses in the portfolio distribution of returns whereas the financial derivative schemes developed by advanced and complex mathematical models were so complicated that nobody, sometimes even mathematicians themselves, could understand sensibly.

On the other hand, the monetary policy perspective of over-leveraged financial sectors has been rather overlooked in policy discussions since periodically low interest rates encourage excessive risk-taking which further facilitated the construction of portfolios with excessively volatile returns that increasingly relied on VaR assumptions whilst fundamentally ignoring the instability of returns from over-leveraged investments. But a more intriguing question pertaining to the banking perspective of financial crises is whether more prudent financial regulation as envisaged from recent stress tests by European Banking Authority can be achieved by raising capital adequacy standards. Unfortunately, the history of Basel accords demonstrates that the banking sector has been prone to search alternative channels to avoid raising capital adequacy ratios through innovative accounting tricks whereas neither Basel I and II envisaged the adverse outcomes from excessive risk-taking. As stress tests indicated, capital adequacy ratios should be increased substantially but, moreover, the regulatory framework should not only build on increasing criteria on Tier I capital and common equity but also on the safeguard despositary insurance of contingent liabilities to mitigate liquidity risk that led to the systemic crisis.

The solution to revive the Eurozone economy and revive it from a decade of flawed political imperatives should not exclude multiple options. The focal point of the Eurozone’s recovery from debt crisis should be to help peripheral countries establishment fiscal prudence, discipline and soundness of the public finances. In fact, the recovery from the debt crisis will endure for more than a decade. The structural adjustment does not rest on the ability of the EU to provide financial assistance to peripheral countries but on the principled and coordinated action to reform inefficient public sectors which are at the heart of the debt spiral since years of generous entitlements to civil servants have tremendously raised the net present value of public debt to the point that peripheral countries are on the brink of default on its external obligations. Without generating substantial fiscal surpluses, there is no feasibility and no realistic scenario under which public debt level would be brought under the control in the near-term perspective. Hence, recent discussions of the consequences of debt crisis in Europe have simply overlooked the importance of growth-enhancing measures as the real cure for growing debt-to-GDP ratio where the measures do not apply to peripheral countries only.

First, in the wake of fiscal insolvency of public pension systems, effective retirement age should be raised substantially for men and women alike. The studies have shown that under the increase in effective retirement age to 65 years, long-term fiscal obligations would reduce and consequently an important step towards long-term macroeconomic stability would be achieved. Nearly every European country is facing low-fertility trap followed from increased affluence and generous early-retirement policies from 1970s onward. Consequently, European government have amounted a mountain of net financial liabilities that exceeded the size of GDP by several times, respectively. Decreasing the size of net liabilities to contemporary and future generations of retirees, requires a robust increase in effective retirement age. Higher retirement age threshold would substantially increase working-age population by encouraging labor market participation among the elderly. Current levels of effective retirement age are unsustainable in the long-run since a growing burden of pension obligations can seriously threaten the stability of the public finance and increase the probability of fiscal insolvency.

Second, European countries suffer from low productivity growth. In some countries, such as Italy productivity growth has remained stagnant over the course of recent two decades while elsewhere productivity growth is to slow to compensate for the increase in nominal wage rates. The evidence, in fact, overwhelmingly suggested that high tax rates are the prime obstacle to greater labor market participation, particularly among the elderly who face high implicit tax rates on work. In particular, to facilitate the channels of productivity growth, marginal tax rates should be decreased substantially. At current levels, marginal tax rates restrain labor supply significantly. In the Netherlands, the top marginal income tax rates reached 52 percent in 2011 which is a serious hinder on the working activity. In this respect, bold tax reforms should be complemented with more flexible labor markets which remain saddled with employment regulations and distort labor supply incentives. Less regulated labor market to supplement greater labor force participation, especially among women, elderly and the youth is vital to enhance productivity growth since living standards by the end of the day are determined by productivity improvements.

Ultimately and most importantly, peripheral countries should be given a free choice whether to withdraw from the EMU since recent financial crisis has shown that Eurozone is a suboptimal currency area which emerged from non-cooperative fiscal policies among its member states that caused adverse outcomes and asymmetric adjustment where macroeconomic stabilization outcomes are mutually exclusive among member states. Asymmetry adjustment that currently threatens the existence and stability of Eurozone lies at the heart of Eurozone’s debt crisis. As a general matter, economic policies have failed to recognize that structural measures in the labor market and fiscal policy regime could facilitate growth enhancement and provide the necessary impetus to stabilization of crisis-impeded monetary union. Recent suggestions by France and Germany for EU member states to form a fiscal union have led to sustained resistance from the UK which dissolved from the fiscal pact.

The ultimate grain of truth in the fiscal union is that a monetary union necessarily requires the coordination of fiscal policies to prevent adverse and asymmetric policy outcomes within the union. The fateful conclusion from recent EU debt crisis is that without the integration of the labor market on the EU level, the monetary integration cannot exist in coherence with asymmetric fiscal policies. In the future, stricter adherence to budgetary discipline will be necessary through budgetary authority. In this respect, countries that fail to adhere to Maastricht criteria and deviate from the fiscal discipline either marginally or substantially should be condemned and pay for their actions of fiscal imprudence by withdrawing from the monetary union.

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Europe Uncertainty Plummets – Deal is Done

Eldon Mast — Thu, 27 Oct 2011 14:15:05 +0000

European Union leaders unveiled a deal early Thursday on debt crisis measures that includes a 50% loss on Greek bonds.

The agreement came at the end of a series of talks to finalize the details of a comprehensive policy response to the government debt and banking problems threatening the stability of the euro currency and global economy.

The deal will likely resolve three related problems: the debt crisis in Greece, instability in the banking sector and an under-capitalized bailout fund.

Under the new plan, Greek bondholders voluntarily agreed to write down the value of Greek bonds by 50%, which translates into €100 billion and will reduce the nation’s debt load to 120% of economic output from 150%.

The agreement also calls for the creation of a new financing program with the International Monetary Fund worth up to €100 billion.

Stronger bailout fund: The leaders agreed on two ways to increase the firepower of the EU bailout fund, known as the European Financial Stability Facility. The methods will each leverage the fund by four or five fold, the statement said, boosting its resources to about €1 trillion.
The fund will be used to partially ensure new issues of government bonds. In addition, it will be supplemented by the creation of one or more special investment vehicles, which will be open to private sector players such as sovereign wealth funds.

The EU heads of state also agreed to raise capital requirements for banks vulnerable to losses on euro-area government bonds.

Banks would be required to sharply increase core capital levels to 9% to create a buffer against potential losses.

Bob Moriarty: Triple-Digit Returns Predicted for Mining Stocks

The Gold Report — Mon, 25 Jul 2011 13:50:12 +0000

With the price of gold hitting record highs and equity prices lagging behind, Bob Moriarty, founder of 321gold.com, says it’s time to gather some precious metals as insurance against hyperinflation or deflation—whichever may be coming our way—and to stock up on junior resource stocks. Prudent picks, he suggests in this exclusive interview with The Gold Report, stand a good chance of yielding returns up to 500%.

The Gold Report: Bob, you’ve told us that you avoid investments that appear to be slam-dunks because they never work out. But you’re a longstanding gold enthusiast, and you hear many people talking about gold as a slam-dunk investment—and now silver as well. How do you reconcile this?
Bob Moriarty: All the attention paid to gold scares me. If you looked at gold in terms of the cost of a postage stamp or a house, gold is very expensive at $1,600/oz. Same thing is true of silver; silver got very frothy two months ago, and every idiot in the world was running around saying silver is going through the roof. We actually had a higher bullish consensus on silver on May l of this year than we did in January of 1980, and that scares me, too.

TGR: You’ve also expressed serious concerns about international governments and their debts underpinning the increase in the gold price. Are you still making that argument?

BM: Well, here’s the key, and this is what the gold bugs totally ignore. You can die of lung cancer or a heart attack, and the end result is exactly the same. In a financial system, you can die of hyperinflation or you can die of deflation. With $600 trillion worth of derivatives in the world, the risk of deflation is enormous, and that means that gold could drop to $500/oz. It might buy 10 times as much as it does at $1,600/oz., but everybody in the gold arena believes we’re going to go into hyperinflation, and that’s a slam-dunk. What if we don’t? What if they’re wrong?

TGR: It’s interesting that you bring up the need to look at the price of gold in terms of what it can buy, but if you believe in the theory that gold at $500/oz. will be able to buy 10 times more than it does today, doesn’t that make gold great regardless of whether we’re in a hyperinflation or a deflationary environment?

BM: Yeah, I absolutely believe that the financial system of the world will collapse—and I think lots of people have now come into this camp. Even Tim Geithner came out just a few days ago saying that we’re in some really, really, bad times. I was saying that five years ago and 10 years ago, and now Mr. Geithner’s finally figuring it out.

But the gold bugs need to understand that Greece could default, Italy could default, Spain could default, starting a series of cascading defaults and the banking system could close in a month. Then maybe gold isn’t $10,000/oz.; maybe it’s $500/oz.

TGR: Speaking of some of those European economies, on July 12 you wrote an article describing Greece as a “serial deadbeat,” and said that the European Union (EU) should kick Greece out and let them sort out their own financial situation or face a revolution. But realistically, wouldn’t kicking Greece out of the EU also trigger a revolution in Europe as the various banking systems begin to collapse?

BM: But they’ll create a far bigger monster if they try to keep Greece in the EU. This is a case of Hobson’s Choice. Hobson was an innkeeper in England back in the 18th century, and he was a lazy sod. When you went to Hobson, if you wanted a horse he would give you whatever horse was nearest the barn door. If you wanted a riding horse, you might wind up with a plow horse, and if you wanted a plow horse, you might end up with a thoroughbred.

Hobson’s choice is the choice of the least bad of alternatives. One alternative is for Greece to go out on its own and sort out its own problems. Another alternative is to have Germany, Sweden, Norway and others in the EU pay for Greece’s problems. Sooner or later, people will say, “Hey, wait a minute. It’s Greece’s problem; it’s not our problem.”

TGR: Isn’t it both? Greece’s problem, but not Greece’s alone.

BM: That’s true. What’s going on in Europe is the most serious financial issue in world history, and once the defaults start to cascade, it will be time to head for the bunker.

Almost everybody believes that governments are all-powerful and can prevent chaos. I believe that market forces are all-powerful. If the banking system in Europe collapses, it will be a week or two before it hits the United States, but I don’t think the government can do anything about it.

A two-year Greek note is paying 39% interest. When you’re paying 39% interest, it means the market believes you’re going to default. The United States is paying probably 0.05% for the same thing, but what nobody has taken into account is globalization means that everybody’s in bed together. So, when Greece and Italy collapse, it’s going to cause a collapse in the United States.

TGR: Tea Party representatives have been adamant that the U.S. doesn’t need to raise its debt ceiling because we can cut our way into living within our means―a position that’s resulted in a complete stalemate in Washington, D.C. while the debate continues. How do you see this playing out as the August 2 deadline approaches?

BM: They’ve pulled the pin on the hand grenade, and they’re tossing the hand grenade back and forth. No one wants to get stuck with it when it goes off. It’s totally insane. If Moody’s downgrades the United States, it would double our interest rates overnight and put every bank in the United States out of business. These guys are playing a really stupid game, and playing it for political purposes. They can’t even understand how dangerous it is.

But to some extent the Tea Party is right, in that we don’t need to increase the debt ceiling. We need to go back to real-world economics and match what we spend to what we collect.

TGR: How can we do that by August 2?

BM: Suppose you called me up and said, “Hey, Bob, I’ve got a problem. I owe $5 million and I make $50,000 a year. I don’t know how I can pay my bills.” I’d tell you that you need to default, start all over, and match your income with what you spend. In that sense, there’s no difference between a country and an individual. Under these circumstances, it’s ridiculous to be talking about raising the debt ceiling. The United States hasn’t paid a penny of the debt off since 1960. It simply cannot go on forever. It’s going to blow up. It has to.

TGR: But wouldn’t defaulting trigger that downgrading by Moody’s, the rise in interest rates, and the bank failures you mentioned? We wouldn’t even be able to pay the interest. If we don’t raise the debt ceiling, won’t our huge house of cards come tumbling down?

BM: It’s going to happen no matter what we do.

TGR: So, how do you see this playing out?

BM: I think they will raise the debt ceiling. But it’s a house of cards, it’s going to collapse here very soon, and everybody’s going to say, “Gee, why didn’t somebody warn us?” The fact of the matter is that 49 other guys and I have been trying to warn people for 10 years now, and nobody’s wanted to listen. People’s heads are buried in the sand because they don’t want to know.

TGR: What do you suppose this will do to the price of gold in the near term?

BM: Gold will drop off in August, as it always does, and then pick up again in September. What’s really interesting to me is that gold is at the highest price it’s been in history and nobody seems to care.

TGR: What do you mean by that?

BM: Well, we’ve got the highest price for gold that we’ve ever had. I was around in 1979 and 1980, and it was a big deal on the news every day. They were tracking the price of gold and the price of silver, and nowadays everybody kind of ho-hums. We’re almost at $1,600 and nobody really cares.

TGR: Could the ho-hum attitude reflect the fact that it’s not really a big market?

BM: I think Americans are so clueless as to what’s going on financially that they don’t understand how important it is. But it is important; it’s a barometer. It’s the canary in the coal mine and it’s saying something is seriously wrong.

TGR: Do you think the fact that gold has been decoupled from currency for several decades might also make it more humdrum?

BM: Yes, that’s absolutely true. Most Americans wouldn’t have any idea what a U.S. gold coin is like because they’ve never felt one, never touched one, never bought one, never sold one. The gold markets and the silver markets are tiny markets now, but I’ve been saying for years you need gold and silver as an insurance policy. Certainly, anyone who reads the headlines today should realize that this is a time for an insurance policy.

TGR: Right, and as you said earlier, it’s an insurance policy for either hyperinflation or deflation. It will work in either direction. Your July 11 article mentioned that the Canadian junior shares have languished relative to the price of gold. So is this also a time to get into gold equities?

BM: It probably is. If you go back to 1980, gold and silver hit their highs in January but the junior market didn’t hit its high until that fall. So gold went up to $875 and then collapsed; silver went up to $50.25 and then collapsed. The stocks didn’t move at all until nine months later. They roared higher when people said, “Okay, it’s time to get into gold and silver.” Sometimes gold and silver lead; sometimes stocks lead, but gold stocks are very cheap now compared to the metal.

TGR: Which means they’ll only get cheaper if the metal continues its upward path.

BM: Obviously. With $1,600 gold, an extraordinary price, every gold mining company in the world should be making money hand over fist.

TGR: You’ve said the best place to find a new mine is to find an old mine. Why is that true?

BM: Mines aren’t usually closed because all the ores have been mined out; they’re shut down for economic reasons. Management spends too much money or busts their picks on another deposit. It’s as simple as going into a known gold or silver district and using modern exploration techniques. I’m writing a piece about a company I went to visit in Colombia. The locals have been mining in the area for 400 years. It would surprise me if they have found 5% or 10% of the gold available there.

TGR: Can you share this company’s name with us?

BM: It’s Red Eagle Mining Corp. (TSX.V:RD ), which just went public toward the end of June. People can get into the stock today at pretty close to the same price that they came out in the Initial Public Offering (IPO), about $1.25 per share. I went; I found gold; I panned gold; I saw gold being mined. Better yet, the company has a big land position. I think it will be very successful. I think anybody in Colombia will be very successful. It’s an extraordinary country.

TGR: You’ve said before that over the next five to 10 years that Colombia once again will be the largest gold producer in the world.

BM: Colombia was the biggest gold producer in the world for 300 years, and there’s still an enormous amount of gold there.

TGR: Did you look at other companies during your visit to Colombia that you consider particularly good investment opportunities?

BM: Continental Gold Ltd. (TSX:CNL) is one; I think its mine has 1 oz. average material. Solvista Gold Corp. (TSX.V:SVV), Sunward Resources Ltd. (TSX.V:SWD), Bellhaven Copper and Gold Inc. (TSX.V:BHV), Colombia Crest Gold Corp. (TSX.V:CLB; Fkft:EAT) and Galway Resources Ltd. (TSX.V:GWY) are a few others. Some 50 companies are located in Colombia. The real issue will be how good the management is, because the gold is certainly there.

TGR: Tell us a little more about some of those companies.

BM: I really enjoyed my visit to Sunward. It’s just a great company and they’re doing good stuff. It’s in an area with a gold-rich copper porphyry. It’s not high grade, with an average of 0.53 grams, but the tonnage is enormous. Sunward could end up with 800M–1B tons, and as the size of the deposit grows, it’s getting cheaper to mine. It has a 3.7 million ounce resource right now, and I expect that to double or triple by the time they finish drilling.

TGR: You said that it gets cheaper to mine as the size of the deposit grows. Is there a point in Sunward where you’ll see a tipping for those economies of scale?

BM: They’re there now, with enough gold to go in with bulk tonnage techniques and really get the costs down.

TGR: Going back to your comment about looking for an old mine to find a new mine, you recently wrote up a company working in a series of old Idaho mines that produced for about 40 years until 1942.

BM: When the United States entered the war after being attacked in December of 1941, the government shut down 165 mines because the men and the equipment were needed for the war effort. In fact, 100% of those deposits were economic. The one you’re alluding to is Musgrove Minerals Corp. (TSX:MGS; OTCQX:MGSGF). Its mine was the biggest copper producer in the United States until the Bingham Canyon in Utah came along. It has a lot of oxide copper right at the surface.

TGR: Given that the price of copper has gone up so much over the past several years, why wasn’t it put into production a decade ago?

BM: A decade ago, copper was $0.65 a pound; today it is $4 and change. There also were some management issues with the company that had the project before Musgrove. Musgrove came in and sorted out the issues, and it’s very viable today. It would be viable probably at $1.50 copper.

I’m not particularly concerned about the price, because everything in life is cyclical. It takes years to develop a mine like this, so you don’t care what the price of copper is on a day-to-day basis. You have to be looking at the long term.

TGR: An interesting company that appears on your website describes its approach as a focus on “generative exploration targeting under-explored gold belts.” That seems contrary to your old mines, new mines proposition.

BM: Despite what that description may imply, Revolution Resources Corp. (TSX:RV; OTCQX:RVRCF) is doing exactly what we were talking about. All of the deposits that they’re drilling now are prior mines that I went to see about two months ago. Revolution is indeed exploring, but it’s in an area known for America’s first gold rush, for the oldest silver mine in the U.S. and for the fact that it led the country in lead production for Civil War munitions.

TGR: The first gold rush?

BM: In 1848, when gold was discovered in California, the miners from the Carolinas and Georgia all headed for California. The head of the U.S. Mint in Dahlonega, Georgia tried to convince them to stick around Georgia because there was so much gold there. The phrase “Thar’s gold in them thar hills” is how he put it, to persuade them to stay. The Carolina Slate Belt, which produced more gold than anywhere else in the country until 1848, may still be the most prolific mineral belt in the eastern United States. When Revolution management looked at it, they said, “These things didn’t stop producing because they ran out of ore; they went out of production because of economics, and we’ll go back in with modern techniques.” I think Revolution is going to be a wild success.

TGR: Have you researched or analyzed any other companies in base metals or precious metals that you’d like to talk about?

BM: I don’t think so. Across the board, mining stocks are so cheap that if a company passes the management test, you could have a 200%, 300%, or 500% return.

Convinced that gold and silver were at their bottoms, and wanting to give others a foundation for investing in resource stocks, Bob and Barb Moriarty brought 321gold.com to the Internet 10 years ago, and later added 321energy.com to cover oil, natural gas, gasoline, coal, solar, wind and nuclear energy. Both sites feature articles, editorial opinions, pricing figures and updates on the current events affecting both sectors. Before his Internet career, Bob was a Marine F 4B pilot and O 1C/G forward air controller with more than 820 missions in Vietnam. A captain at age 22, he was the youngest naval aviator in Vietnam and one of the war’s most highly decorated. He holds 14 international aviation records, and once flew an airplane through the Eiffel Tower’s pillars “just for fun.”

Can the Eurozone Survive?

Rok Spruk — Mon, 27 Dec 2010 20:18:10 +0000

The ongoing difficulties in overcoming the persistence of debt-to-GDP ratio in EU countries highlight the question whether the European Monetary Union can survive the set of shocks which prevailed since the 2008/2009 economic and financial crisis. Recently, European Commission has presented the 2010 review of public finances in EMU (link), suggesting that macroeconomic outlook for Eurozone economies has deteriorated in the light of a growing debt-to-GDP ratio.

The launch of government bailouts in various European countries has added considerable amount to the stock of public debt across the Eurozone. Since 2008/2009, general government balance in Eurozone countries has continually resulted in persistent government deficits which further added to the stock of debt. Since public debt is by definition the sum of previous deficits, the European macroeconomic outlook suffers significantly from downgraded stability of public debt.

The anatomy of sluggish economic recovery in Eurozone consists of different set of economic policies. Countries at the European periphery (Portugal, Ireland, Greece, Italy, Spain) seem to be hit most by the sluggish economic recovery. From the viewpoint of macreconomic stability, the economic policymakers in these countries have pursued the most discretionary economic policies to mitigate the effects of decline in GDP on employment, earnings and tax revenues. In addition, highly expansionary monetary policy by the European Central Bank provided a bulk of quantitative easing, resulting flooding liquidity to supplement the interbank lending and, hence, to contain the effect of overleveraged financial sector on macroeconomic stability. In Ireland, income per capita in 2010 notably decline back to 2004 level (link). As I previously emphasized in one of my previous posts (link), the depth of the economic crisis in Ireland is largely attributed to the overleveraged banking sector, vulnerable to the interbank interest rate increases. Since the sovereign CDS spread on Ireland exceeded 500 basis points in late September this year, the Irish public finance outlook deteriorated significantly in the light of the innate ability of the Irish government to bailout Anglo-Irish Bank. Recently, the IMF estimated (link) that by 2012, Irish debt-to-GDP ratio would reach 67 percent, up from 12 percent in 2005.

A prudent reduction in debt-to-GDP would be accomplished only under restrictive fiscal policy based on the reduction in government spending and a permanent fiscal rule on budget surplus at a given target level. If Irish government set the surplus target at 3 percent of GDP in the next ten years, debt-to-GDP ratio could be considerably reduced within the range of Maastricht fiscal criteria.

The macroeconomic outlook in peripheral countries suffers from high fiscal expenditures and rigid labor market institutions. By 2012, Portugal’s debt-to-GDP ratio is expected to reach nearly 85 percent of GDP. In addition to soaring public debt, the Mediterranean part of the EMU suffers heavily from high unemployment rate. Eurostat recently reported that, by October 2010, the unemployment rate in Spain reached an astonishing 20.7 percent. Double-digit unemployment rate in Spain, Greece (12.2 percent) and Portugal (11 percent) hamper the economic recovery since, in the past, these countries exercised expansionary fiscal policy and the policy of automatic stabilizers to mitigate the effects of high unemployment on aggregate consumption decline. In the aftermath of financial crisis, these countries experienced recessionary output gap in which economic contraction is marred by unchanged inflationary pressures.

Since EMU countries withheld domestic currencies and adhered the adoption of the Euro, the macroeconomic adjustment to the recovery is possible only by a prudent fiscal policy. High unemployment rates and a persistent divergence of economic policies in EMU countries could substantially increase discretionary fiscal policies that would eventually result in the serious possibility of country default. The economic crisis in Greece resulted in 11 percent cumulative GDP decline between 2010 and 2012. In the same period, government net debt is expected to reach the 120 percent of GDP thresold. A divergence between Member States towards highly discretionary fiscal policy would probably alleviate the persistence of high unemployment but at the expense of bold increase in the rate of inflation as well as in the persistence of debt-to-GDP ratio and large government imbalances. Hence, the survival of the Eurozone would depend on the ability of EU Member States to adjust government balance by reducing fiscal expenditure and adopt the fiscal rule to pursue fiscal surplus in the coming years as to reduce the stock of public debt.

Even though a common fiscal policy could accomplish the goals of stabilization policy, the mitigation of fiscal asymmetries would be easily accomplished by labor market integration. A currency union between different countries implies integrated and assimilated labor markets under relatively homogenous preferences. It would be nearly impossible to envision the European Monetary Union without these key macroeconomic features.

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Who is Next in the Eurozone?

Claus Vistesen — Fri, 19 Nov 2010 18:10:21 +0000

The Eurozone seems to be the place where the party never ends these days as one skeleton after the other comes rattling out of the closet. Indeed, one has the impression that history is in the making these days and the only thing we can hope is that it will be for the better.

In truth however, I felt a good measure of sympathy for Ireland today as I read the Bloomberg report about how the country is now essentially on its way to accepting a deal that will have aid delivered from the EU, the IMF and, most painfully, from England.

Irish rebels fought for independence during World War I, boasting they served “neither King nor Kaiser.” Ireland may now have to do exactly that to qualify for a bailout partly funded by both Britain and Germany. Prime Minister Brian Cowen is edging toward accepting a rescue package that may threaten the country’s low-tax policies and put voters on the hook to repay loans the central bank says may be worth “tens of billions” of euros. For critics of Cowen’s Fianna Fail party, which governed Ireland through its decade-long boom, national pride is at stake. Cowen has “squandered” independence for a “German bailout with a few shillings of sympathy from the British chancellor,” the Irish Times newspaper said yesterday. The government should be “ashamed that Fianna Fail should be the ones to surrender sovereignty,” said Michael Noonan, finance spokesman for Fine Gael, the largest opposition party.

However, Ireland largely made the mistakes itself of which the biggest no doubt was to guarantee its banking system and essentially gamble that a) the economy could swallow the liabilities of its broken banks (which with a deficit of 32% of GDP in 2010 it obviously can’t) and b) that help could be reached elsewhere.

Iza’s report yesterday over at FT Alphaville about just how much European governments have promised during the past 2 years makes an extraordinarily important point and it well worth reading in its entirety;

As all eyes focus on what should be done about the Irish banking crisis, perhaps it’s time for the European Union, IMF and other related parties to take a closer look at some of the factors that may have exacerbated the problem. After all, it’s now becoming abundantly clear that the dishing out of an elaborate 100 per cent deposit guarantee back in September 2008 was largely nothing more than a massive bluff designed to steal attract deposit flows from neighbouring states to for the purpose of propping up Irish banks. Furthermore, as we’ve mentioned already, the EFSF is already turning out to resemble something like Paulson’s bazooka in its own right too. Which means — with everything becoming a high-stakes game of ‘Call my bluff‘ — it could be time to restrict the ability of sovereigns generally to randomly guarantee things they clearly can’t afford to guarantee in the first place. (If confidence in the Eurozone is to be restored properly that is.) After all, let’s just look at the dynamics of the Irish deposit guarantee itself.

So, this is about a deposit guarantees which if course is one of those guarantees a government never really can make due on in the case of the ultimate rout à l’End of Days. Yet, the point has general validity far beyond the issue of deposit guarantees. Basically, Ireland promised to make due for its banks … now that it appear that she can’t, it is up to the rest of the Eurozone to pay.

No doubt this view is shared in principle as well as sentiment by the prowling Proell from Austria who recently fired two stray missiles into the raging debate on how best to deal with the issue of solidarity in the Eurozone. Earlier in the week, he raised serious questions about whether Austria would make due on its promist to spit into the common funding scheme for Greece now that it was obvious that the country was missing its budget target yet again and most recently, he said to Bloomberg reporters that he was very interested in talking with Ireland about its famously low corporate tax rate in connection with the bailout.

You know, quid pro quo and all that.

Now, before we get into the blame game I should note that I agree with the Economist in their most recent take on the Eurozone mess in which they implicitly highlight that while timing is always difficult in politics there is still a continuum between good and bad and Merkel’s sudden urge to remind bondholders that they too might take a loss falls in the latter category.

At an EU summit at the end of October the German chancellor won agreement that any future euro-zone rescue scheme should include a mechanism for an orderly sovereign-debt default. The principle was absolutely right: unless default is a possibility, bond investors have no reason to distinguish between good and bad credits. But the idea of making bondholders lose money when sovereign credits turn sour was aired without any guidance about how and when it might apply. Astonishingly, the Germans failed to put together a detailed proposal for the summit.

I should make it clear that I fully back to idea of bondholders taking their share of the loss since if this is not a real possibility there is no way in which to secure an orderly default which is inevitably coming sooner rather than later to some of the most vulnerable Eurozone economies. Especially, and going back to Izabella’s point above the practical distinction between using bailout funds for governents and not banks is a mirage exactly because promises have been made and anectodal contracts have been signed with the electorate and, one is tempted to note, the devil herself. As I have said before, you may not like it and I agree with Izabella that the EU and IMF would be wise to monitor just what promises that are made in the future.

And speaking of promises; if Ireland seems to be mellow enough to be put into the bailout fold, there is another small country left in the waiting room in the form of Portugal. Again I think that the Economist has the right answer;

If only both sides gave up posturing, they would agree that the European rescue funds should be used to stabilise Ireland’s banks, insisting only on certain budget targets in return. Such a deal should satisfy Ireland’s euro-zone partners, which want an end to the uncertainty, and the European Central Bank (ECB), on which Ireland’s banks have become overly reliant for funding. It would also be wise to offer a similar deal to Portugal. Its banks are dependent on ECB support, and it too is in the bond markets’ sights.

I am not exactly tuned up on the actual difference between just pouring money into the banks or giving it to the sovereign which then uses the funds to make due on a foolhardy promise to secure the entire domestic banking sector’s liabilities. But really, the distinction should be next to none I think. And if you think that all this about Portugal is just me trying to kick up a bad mood, Bloomberg pulled one better on me with this elegant report about how investors are turning their attention away from Ireland and over to … well, you guessed it I think;

The markets indicate that country is Portugal with 10-year bond yields of 6.88 percent, compared with 8.26 percent in Ireland and 11.62 percent in Greece, which received rescue funds in May from the European Union and International Monetary Fund. Portuguese Finance Minister Fernando Teixeira dos Santos said Nov. 15 that while “there is a risk of contagion,” that doesn’t mean the country will seek financial aid. “Portugal isn’t in the situation that it is now because of Ireland,” said Steven Mansell, director of interest-rate strategy at Citigroup Global Markets Ltd. in London. “If Ireland reaches an agreement to tap the European Financial Stability Facility or some other mechanism to support its banking sector, I don’t think that will alleviate the pressure on Portugal.”

So, it seems as if the next stop might very well be far western rim of the Eurozone and its beautiful Algarve coastline.

Has the Market Finally Gotten it on the Eurozone Periphery?

Claus Vistesen — Wed, 27 Oct 2010 19:43:59 +0000

Popular wisdom has it that markets are always right or, more appropriately; that if you find your self on the wrong side of the market consensus the best cause of action is to join the ranks less you want to be rolled over by a steamroller. However, it may take some time before the market corrects to the underlying fundamentals or so, at least, I will argue.

Last time I wrote on Ireland I noted how the country’s latest move to emphasize its strong cash position (as well as the fact that it announced the intention not to go to market to seek financing) was a wink to EU policy makers that either the current plan works or Ireland will need funding help. Private market funding at current and future expected rates is not an option and the really important question is whether the interest rates charge by some form of European SPV would also be consistent with a recovery or simply another debt spiral. I have my doubts here.

Indeed; with a the running deficit to GDP of 32% in 2010 it is absolutely necessary that Ireland addresses this as a first priority. No matter how much cash you have lying around or how much you expect to be able to get from a coordinated relief program (essentially borrowing with low rates and long maturity), the failure to react now would mean that the time path of public debt would prove instantly unsustainable as we moved into 2011 and 2012

However, markets don’t seem to be very comfortable with the prospects of very strong austerity measures in Ireland.

Quote Bloomberg

Bond investors are losing faith in Ireland’s plan to lower the deficit as spending cuts threaten to undermine economic growth, reducing government revenue. Irish 10-year bond yields climbed within 50 basis points of the 454 basis-point record spread, set Sept. 29, relative to similar-maturity German bunds. Portugal’s spread fell about 1 percentage point against the German benchmark in the past month, the Greek-German yield gap narrowed 102 basis points and the Spanish spread was close to the lowest level since Aug. 10.

It is important to understand the underlying message here. What drives the worry is not so much the debt and deficit itself, but more so that the severe austerity measures needed to restore the evolution of debt will derail the economy and thus become counterproductive. Indeed, this is the main issue which most OECD economies grapple with at the moment.

But surely, it is not easy being Ireland at the moment. On one day, spreads climb because you are trying to plug the hole in the budget as you try to salvage a broken financial sector and the next spreads climb on growth fears as you introduce austerity measures in an attempt to correct the deficit incured in the first place.Look up the old proverb of being stuck between a rock and a hard place and you will find the European Periphery as a chief example.

What is interesting in particular are the comments extracted by Bloomberg from various fixed income portfolio managers across Europe. They seem to me to be getting closer to a does not compute moment of their own (all quotes are gathered by Bloomberg). Firstly, Dermot O’Leary, chief economist at Goodbody Stockbrokers simply turns the focus upside down and argues that now, surely, growth is the most important goal for Ireland.

“With the scale of consolidation now known, the department’s strategy for returning the economy to growth” could “now be described as more important than the consolidation measures,”

I wonder whether he would change his mind if the black hole of Anglo Irish takes the 2010 deficit/GDP figure to 40% (or perhaps 50%?). But there are other much more fundamental issues being raised; for example by John Fitzgerald a member of the central bank board.

The risk is “the medicine is too severe so that, like chemotherapy, it puts the patient into decline,”

Indeed, this is a risk and one which I (and others) have been banging on about the last 2 years, but the one I really liked was the comment by Ralf Ahrens from Frankfurt Trust and the simple yet crucial question;

“There is this central question of where does growth come from.”

Well, well. Aren’t we coming full circle here?

Allow me to repeat three questions I posed recently in relation to the ongoing efforts to solve the the crisis in many European economies.

How do you correct external competitiveness deficiency from within a currency union at the same time as implementing fiscal austerity without risking debt levels to spin out of control?
How long should Southern Europe and Ireland endure deflation relative to the core to restore external competitiveness (will Germany accept a lower external surplus as result)?
How might a sovereign restructuring in a Eurozone economy play out?

The first question is really the main issue at hand. In the absence of nominal currency devaluation you need to impose wage restraint and deflation in order to correct a large external balance. As this large external imbalance is reflected in a large domestic debt level there is a real risk that if the entire correction must come from the domestic price level, the level of debt in itself will spin out of control which then manifests itself in either large scale private sector defaults or default on the sovereign level.

The main message here is simple macroeconomics. If you combine deflation and negative nominal growth rates over a prolonged period of time and given an already elevated debt level; your overall level of debt relative to the value of your activities (GDP) quickly become unsustainable.

So how do correct then? Well, not without a little help from your friends which brings us to the second question.

Consequently, this is not only about the European periphery suffering, it is about them suffering more than everyone else. Indeed, the recent ascent of the Euro is no good for them in so far as goes competitiveness outside the Eurozone and even inside Europe, it is starting to look like everybody’s race to the bottom in terms of on whose back intra-Eurozone imbalances are supposed to correct. Naturally, a steady depreciation of the Euro would, strictu sensu, be welcome news for Greece, Ireland et al. Yet, this seems far off at the moment with the Fed doing the printing and the ECB reluctant to add further stimulus. On the concrete question of time, you just need to slice up the effects of say, a 30 % nominal devaluation (e.g. against the Euro or USD) which is the likely alternative scenario, I think, if any of the most troubled Eurozone economy had their own currencies. It then means that we would need to see a prolonged period of relative deflation to Core Europe.

This however would in itself be problematic since 5-10 years of slow pain would almost certainly result in a Japan type lost decade, but also be almost impossible from within the Eurozone (i.e. politically). So by proof of elimination we reach question three. Indeed, PIMCO’s El-Erian recently argued that Greece is likely to default within 3 years and that this need not be cataclysmic. I fully agree.

It is impossible to do any form of calculation here since we don’t have any numbers that are coherent, but surely I would think that something along the lines of a 30% haircut on the principal and a notable extension of maturity is a likely result (but really, I have no idea!). The alternative would be that the rest of the periphery follows Ireland’s example and simply leave the private market (although China et al. have indeed been fishing lately) and thus, they would have to be capitalised slowly from within an intra Eurozone structural fund (or through outrigth monetization by the ECB, but this is not going to happen I think).

In the event of restructuring, big the question of the hole left on the balance sheet of Eurozone debt holders of peripheral bonds (let us think about foreign holders later). A couple of potential solutions have already been put forward.

Leaving aside the Structural Fund which is not supposed to recapitalise private entities (at least not yet) it would mean that those banks either would have to enter the market to recapitalise, be recapitalised by their domestic governments (a deal which could form part of the default), or simply transfers bonds at par to the ECB which tend would have to take the hair cut on its balance sheet.

At the end of the day, this kind of rhetoric is still seen as fearmongering and disruptive in the Eurozone collective since there is still a strong sense of resolve around the fact that no sovereign in the Eurozone may be allowed to default/restructure on its debt. As such, you could argue that one glaring omission in my analysis is that I don’t consider the costs of default. Well, they would naturally be substantial not only for the individual economies but for the Eurozone itself. However, when you run even a rudimentary simulation of the likely numbers it is pretty easy to see how this cannot go on. There is no exogenous source of economic growth that will help the periphery move in to a virtuous circle, there is only one big vicious one in which more austerity brings lower growth and deflation which in turn affects the level of debt to GDP.

I admire resolve and I even believe that it is merited, but this is only to the extent that Germany (and France) are willing to assume their part of the bill (which will be very big) or to the extent that the ECB decides to employ wholly new and Fed-like policy tools.

Absent this and leaving aside the question of whether Germany and France realistically would be able to foot the bill at all, the only question is if the markets are starting to get it, when will the shoe drop on the level of macroeconomic policy making?

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Greece Raises the White Flag

Claus Vistesen — Mon, 26 Apr 2010 11:27:27 +0000

Earlier this week Edward mused about whether we were about to see movements in the Greek trenches as yields on 10 year bonds rose to a record 7.76 per cent at one point and closed up 26 basis points on the day. Today, as yields on 2 year bonds flirted with the 10% marker Greece opted to call in the outstanding favor from the IMF and the EU at about as 45 billion euros ($60 billion) put up as a financial lifeline (and in an attempt to calm markets) a little over a week ago.

(quote Bloomberg)

Greece called for activation of a financial lifeline of as much as 45 billion euros ($60 billion) this year in an unprecedented test of the euro’s stability and European political cohesion. The appeal for help from the European Union and International Monetary Fund follows a surge in borrowing costs to what Greek Prime Minister George Papandreou called unsustainable levels that undermine efforts to cut a budget deficit of more than four times the EU limit. Greek bonds and stocks rallied after the announcement.

“There was no response from the markets, either because they didn’t believe in the political will of the EU or because they decided to go on with speculation,” Papandreou said today. “The situation threatens to demolish not only the sacrifices of the people but also the regular course of the economy. All the efforts by the Greek people are in danger of being in vain.”

With national debt of almost 300 billion euros and investors demanding almost triple what they charge Germany for its 10-year bonds, Greece faces a fiscal mess that threatened to spread to Spain and Portugal, forcing the EU to set up a standby aid facility. At stake is the future of the euro 11 years after its creators gave the European Central Bank responsibility for interest rates while leaving budget policy in national capitals.

Obviously, this is more like to be the end of the beginning than the beginning and as Greece readies itself to receive the loan (which will be tallied at 5%) other countries are sitting in the holding room waiting for the doctor to call them. Spain and Portugal come immediately to mind here and it remains to be seen whether Germany or indeed the EU or the IMF have the will and capacity to take another tête-a-tête with the market as Portuguese and Spanish spreads begin to widen. Of course, we are not there yet and it is still highly doubtful that the current plan will help Greece to avoid a default.

Activating the aid and turning over economic policy to EU and IMF oversight was “a new Odyssey for Greece,” Papandreou said. “But we know the road to Ithaca and have charted the waters,” referring to the return of mythological hero Ulysses to his island home.

We should consequently remember the debt snowball here and my guess is that 5% is still way too high a levy to pay for Greece with the nature of nominal GDP growth the country can expect in the coming years as deflation is imposed on the economy. We will see soon enough, but my feeling is that part of the whole policy rigamole that will now unfold, Greece will have to “restructure” notable chunks of her debt.

Finally and on a brighter note, markets do not seem to be able to decide whether this is good or bad for the Euro. Consequently, Bloomberg’s ever flashing newsstream today pitted CMC Markets’ chief market strategist Ashraf Laidi predicting the Euro to move down to 1.27 to the USD against Commerzbank analyst Ulrich Leuchtmann who predicted the Euro to gain on the “successful” bailout.,

Well, well … place your bets accordingly gentlemen. Unlike in Greek’s case he who ultimately raises the white flag should be able to live another day.

Demographics and the Anatomy of International Capital Flows

Claus Vistesen — Mon, 12 Apr 2010 14:49:21 +0000

After a week where the deck of cards that make up the Eurozone got its so far largest jolt and where there is now not only an imminent danger of a total economic collapse in Greece but also, much more worryingly, signs that Germany herself are beginning to tire of a common monetary union I thought it would be nice to take a longer term and structural perspective on the global economy. And what better way to do this than to dig into the world of academia.

As some of you may know I recently earned my degree from the Copenhagen Business School and on that occasion I also produced a thesis which I’d like to share here.

This thesis is built upon two core arguments. The first is the notion that the demographic transition should be narrated through the perspective of ageing rather than population growth and the second is that ageing on a macroeconomic level represents a strong driver of international capital flows. These two arguments are used to discuss the standard prediction in a life cycle framework that ageing leads to dissaving in the aggregate and thus how old economies should tend towards running current account deficits. Using Japan and Germany as the subjects of analysis, this thesis develops the idea that rapidly ageing societies are not, in the main, characterized by dissaving but rather by the fight against it. Finally, a small empirical exercise acts as a perspectivation on the results to suggest why ageing might lead to a reliance on exports and foreign asset income to achieve growth and what this means in a global context.

In many ways, the ideas, thoughts and arguments that have gone into this work are shaped by the discussions and the activity here at this space and my interaction with the people I have come to know through my online presence. In this way, it is only apt that I present it here I think.

I believe that works such as this (and any other academic/economic piece of research) should be judged on two separate accounts. One is its contribution to the methodology, discourse and lingo of its specific academic field which in my case is international macroeconomics and the second is on its contribution to the more market and policy oriented aspect of its topical sphere which in this case is the international economy and in particular global current account imbalances. I believe my thesis has something to offer on both accounts.

On the first, I will immediately disappoint the purists in announcing that my thesis does not develop a new model although I believe there are clear pathways from the arguments for anyone who likes to tinker with neo-classical modelling. In stead, I think there are two important points that I would like to emphasize as future reference and working points for my academic colleagues.

The first is that economists need a much more broad and dynamic theory of demographic changes than is the original idea of a demographic transition. In my thesis I present this through an attempted coup de grace of the notion that demographic changes should be seen through the perspective of population growth. As an alternative I propose a focus on population ageing. In itself this is not controversial and is already an inbuilt narrative in many (if not most) macroeconomic studies that deal with demographic change [1]. However, my aim here is more fundamental. What I consequently want to establish is the simple fact that the demographic transition is not over and not only that, it is non-linear and path dependent. Once we realize this, it opens up a whole new area of research in which macroeconomics is fused with anthropology and life course theory (sociology) in a way which I believe is crucial in order to truly understand what the macroeconomy, as we tend to call it, actually is.

Second, I raise and discuss the issue of dissaving as a function of old age. Specifically, I imply (although I do not show formally) that what may appear obvious on the microeconomic level may not be so obvious on the macroeconomic level. In other words, there is a an aggregation problem [2] here and it is exactly tied to the fact that while dissaving may seem imminently rational and inevitable in a microeconomic perspective it is not all obvious to me why societies as a whole should want to dissave in the context of persistently low fertility rates and rapid population ageing. Realizing that dissaving will at some point be a binding constraint for e.g. an economy such as a Japan in which ageing simply continues relentlessly, I develop the idea that rapidly ageing societies are not, in the main, characterized by dissaving but rather by the fight against it which has come to represent the key proposition of my thesis. I show this in relation to Germany and Japan as the two oldest economies in the world and try to build frame of reference on which to examine and judge other economies who will inevitably move in the same direction as these two economies.

Finally, and on the second overall account it is with no hesitation whatsoever that I claim how my thesis goes a long way to frame the Gordian knot currently facing the global economy as it exits its worst recession since the great depression. In short, if ageing economies find it difficult to create growth based on domestic demand and momentum and if they are reluctant to rapidly dissave into a very uncertain future where they would rely on foreign credit, the logical consequence is that they must be dependent on exports to grow. Now, the onset and path of this export dependency may vary from country to country, but in a world where all economies are ageing and where, worryingly, a large host of economies are converging to very low levels of fertility, it creates an obvious and practical problem. Who is going to run the deficits to match the desired level of savings of all these ageing economies?

Naturally, not everybody can export at the same time but just take a look at the discussions currently characterising the global economy. Everyone who is claiming a recovery is claiming one on the basis of growth in external demand, but this obviously cannot be true. So, you get the trade wars between China and the US, you get internal squabbles in the Eurozone over whether Germany should sacrifice its competitiveness and just how Greece, Spain etc are suppose to pay down their debt while seeing some form of growth at the same time. All this is about a lot of economies feeling the real and future pressure of deleveraging while only a few brave souls dare to proclaim that they seek growth through domestic sources. Something has to give and one obvious result will be lower trend growth quite simply because there will be lower accumulation of debt either because the capacity to pay off debt has shrunk or because the current level of liabilities disallows any further rapid debt accumulation. However, another consequence will also be an externality represented this higher level of desired external savings present in so many economies at the same time and behind it all, as a the underlying current, I believe is demographic change and how it affects the working of modern capitalist systems.

So, am I going for an early catch of the nobel here?

Hardly and thus the thoughts above represent my attempt to take the conclusions of my work as far as possible (and possibly way too far) on an overall conceptual level. Consequently, if you care to leaf through the thing, you will see lots of concrete empirically rooted points and arguments which are more down to earth than the barrage you have just worked your way through above.

In the end and because of my desire to continue my studies on a PhD level, I have (unconsciously I think) written my thesis with an open end and with many strings that can and should be picked up later. This is naturally what I hope to do in the future. For now, I invite you to have a look and by all means do not read it all, but you may just find some it interesting. Comments of all kinds are naturally welcome.

—

[1] – After all, it goes back to the idea of a life cycle and more formally the notion of overlapping generations which are two classic methodological concepts in macroeconomics.

[2] – Aggregation problems are not new of course and have haunted macroeconomic representative agent modelling for a long, long time. However, I think that the specific issue in the context of the life cycle in many ways represent the original sin in the context of aggregation problems (but I may be wrong here).

Islamophobia in Europe

Mary Nichols — Mon, 04 Aug 2008 00:42:28 +0000

According to a recent article in the New York Times Magazine, Europe is in the grip of “an anti-Islamic bias that is becoming institutionalized in the continent’s otherwise ordinary politics.” In the UK, a research report published earlier this year by the Institute of Race Relations argued that Islamophobia is hindering efforts to integrate Muslims into European societies.

The growing hostility towards Muslims in Europe is often linked to the fear of terrorism and associated concerns about the increasing involvement of young Muslims in radical political movements with connections to Al Qaeda. Yet Islamophobia has not emerged to any notable extent in the United States, despite the experience of the September 11 terrorist attacks, suggesting that other factors are also driving the phenomenon in Europe. In any case, Islamophobia had been observed in Europe for some years before the September 11 attacks, linked to concerns about the increased involvement of Muslims, especially of North African origin, in domestic European politics. Although there was undoubtedly a rise in anti-Islamic views and discrimination after September 11 and the London bombings of July 2005, these attacks only served to exacerbate a phenomenon which was already on the increase.

Islamophobia takes a range of forms in Europe, including the more traditional types of socio-economic discrimination and racist attack historically suffered by other ethnic or religious minorities. However, its distinctive feature – as documented by the New York Times article – is the extent to which it has infiltrated European mainstream politics and culture. In recent years many high-profile incidents from across Western Europe have exemplified this trend: the publication in Danish newspaper Jyllens Posten in 2005 of a cartoon portraying the Prophet Mohammad as a terrorist; the online release earlier this year by Dutch right-wing politician Geert Wilders of the movie Fitna, which directly links Islam with terrorism; the banning in French schools of the Islamic hijab, or headscarf, and the debates which are raging throughout Europe over the right to build mosques.

Political Encouragement

The growth of Islamophobia and its seep into mainstream politics have been attributed to the recent strategies of political parties on the Far Right. These have repackaged their traditional messages in a lighter form in order to capitalize on widespread concerns among many European populations about high levels of immigration to Europe and the impact of this on jobs, crime rates and the like. As these parties make political gains, as has been the case in the Netherlands, Italy, Denmark and Austria for example, mainstream parties often adopt similar themes, reinforcing the anti-Islamic stance in national politics. The media also plays a big role: several studies have documented evidence of a bias against Muslims in newspaper reports in countries including Germany and the UK, and more generally there has been much sensationalist reporting about the threat of Islamic terrorism which fails to distinguish between radical Islam and Muslims in general.

Some writers have linked the development of Islamophobia in Europe to the relatively homogenous nature of European populations, the associated development of strong national cultures and identities and a tendency for integration of immigrants to be regarded as synonymous with assimilation. When immigrant cultures or religious beliefs are seen to clash with dominant national ideology, as has occurred in many European countries in the case of Islam, the people concerned are seen as a threat to national identity and become the target of discrimination and prejudice.

Other Factors

Socio-economic factors also play a significant role in contributing to Islamophobia and the factors that drive it. Compared with the U.S., where Muslims are on average better educated and higher earners than the native population, Europe’s Muslim populations are concentrated in low socio-economic groups, at least in part because of the structural discrimination they have experienced over time. This not only makes them an obvious target for racism among those who see them as direct competition for low-skilled jobs but also generates a pool of Muslim youths who are alienated from societies which offer them few rewards and are ready prey for Islamic fundamentalist movements.

A number of European countries, alerted by the threat to their social stability posed not only by Islamic extremism but by growing Islamophobia, are now taking steps to promote better dialogue with their Muslim communities and to enforce new anti-discrimination legislation. This is a positive development for Europe, yet such measures may only be able to skim the surface of a problem which appears deep-rooted in a multitude of cultural, political and socio-economic factors.

References

Al-Azmeh, A. & Fokas, E. (2006). Islam in Europe: Diversity, Identity and Influence. Cambridge: Cambridge University Press.

Cesari, J. (2006). Muslims in Western Europe After 9/11: Why the term Islamophobia is more a predicament than an explanation. Submission to the Changing Landscape of Citizenship and Security. 6th PCRD of European Commission.

Fekete, L. (2008). Integration, Islamophobia and civil rights in Europe. London: Institute of Race Relations.

Feldman, N. (2008). The New Pariahs? New York Times Magazine, June 22, 2008.
Ford, G. (2007). In the wake of xenophobia: the new racism in Europe. UN Chronicle. September 2007.

Saeed, A. (2007). Media, Racism and Islamophobia: The Representation of Islam and Muslims in the Media. Sociology Compass 1, 2: 443–462.

The Unclear Impact of EU Migrants to the UK

Mary Nichols — Wed, 09 Jul 2008 21:55:07 +0000

When Eastern European countries joined the EU in 2004 and 2007, concerns were raised about a possible flood of migration to the UK, a country already experiencing record immigration levels. According to some media reports, not only would the British labor market be overrun by low-skilled East European workers but the widening of the EU boundaries would also result in a surge of illegal migrants who would easily slip in through countries with weaker immigration controls. It was argued that these developments would have adverse impacts on the British economy since the East European immigrants would accept low-paid work, reducing wage costs and increasing unemployment levels among native workers and thus suppressing prices and economic growth.

Many other EU countries decided to protect their labor forces from East European migration by exercising the right to impose a seven-year ban on working for the new EU citizens. Great Britain allowed most new EU nationals to take up employment in the UK immediately, subject to registration with the government. In the face of rising public concerns about immigration, it did, however, impose temporary restrictions on the numbers of Romanian and Bulgarian nationals allowed to work in the UK after these two countries were admitted to the EU in January 2007.

What is known about the impacts of East European migration on the British economy to date? Any findings will have considerable significance for the debate about immigration and the economy, which has long occupied the minds of academics and policymakers on both sides of the Atlantic.

Crying Flood

First, actual levels of East European migration to Great Britain have been much lower than some observers had feared. Data from the British Government’s Worker Registration Scheme indicate that around 800,000 East European migrants joined the British labor force between May 2004 and the end of December 2007; by 2008 it was being reported that applications for employment had dropped to their lowest levels since 2005. Moreover, the available data suggests that up to half of all East European migrants have returned home after a period of working in the UK.

Synthesizing the findings of a range of studies, a House of Lords report published in April reported that immigration results in clear “winners and losers in economic terms.” The winners in this economic contest include the immigrants who land jobs as well as the employers who are able to fill their vacancies at relatively low wage rates, while the losers include those directly competing for low-skilled or low-paid jobs, including many immigrants already in the country as well as young entrants to the labor market. For the economy as a whole, the House of Lords report concluded, immigration may not be beneficial due to its suppressing effects on labor costs and thus on the price of goods and services.

However, academic research for the British Government published more recently in June, The Impact of Migration from the New EU Member States on Native Workers, claims to provide data showing that East European migration has had no adverse impact on unemployment or wage levels among the existing British population and has increased annual levels of economic growth by 0.15% per capita.

The Extremities of the Population

Globally, researchers have not been able to reach a consensus about whether immigration in general has a positive or negative impact on a country’s economy – some argue that the costs and benefits cancel each other out so the overall effect is in any case minimal. The lack of conclusive findings may be explained by the results of a UK study, Migration: an economic and social analysis, which concluded that immigrant characteristics are more polarized than those of the general population, often including extremes of wealth and poverty, concentrations of high-skilled and low-skilled workers and of employed and unemployed (or economically inactive) people.

The overall impact on a country’s economy will clearly depend, therefore, on the profile of its immigrant population as well as prevailing labor market conditions and the need for particular types of workers. Moreover, the social effects of immigration and their indirect economic impacts must also be included in the equation: the UK Border Agency recently reported that in the majority of English regions, recent migration has resulted in pressures on housing and education and in crime problems.

See Also

Blanchflower, D., Salaheen, J. & Shadforth, C. (2007). The impact of the recent migration from Eastern Europe on the UK economy. Discussion Papers 17. Monetary Policy Committee Unit, Bank of England.

Glover, S. Gott, C., Loizillon, A., Portes, J., Price, R., Spencer, S., Srinivasan. V. & Willis, C. (2001). Migration: an economic and social analysis. RDS Occasional Paper No 67. London: The Home Office.

Home Office. UK Border Agency (2008, May 20). Eastern European migration falls (http://www.ukba.homeoffice.gov.uk/sitecontent/newsarticles/migrationfalls).

Home Office (2008). Evidence from our regional consultation on the impacts of migration (draft) (http://news.bbc.co.uk/2/shared/bsp/hi/pdfs/17_10_07_migration.pdf).

House of Lords Select Committee on Economic Affairs (2008). 1st Report of Session 2007–08: The Economic Impact of Immigration Volume I.

Lemos, S. & Portes, J. (2008). The Impact of Migration from the New EU Member States on Native Workers. London: Department for Work and Pensions.

Rowthorn, R. (2004). The Economic Impact of Immigration. Civitas Online Report. (http://www.civitas.org.uk/pdf/Rowthorn_Immigration.pdf).