Jean-Claude Trichet's "apology" and responsibilities

Yesterday, Jean-Claude Trichet apologized at a European Parliament hearing concerning the role of the “troika” of international lenders (which managed bailouts in Cyprus, Greece, etc), with his response surprising many, as he blamed Member-State governments for the situation the EU is currently facing and basically washing his hands off the subject.

What caused some to wonder about Trichet's behaviour was that he did not admit any mistakes made by the Troika (and in essence the ECB, even when the IMF admitted to have under-estimated the GDP projections) and showed no remorse whatsoever. A prevalent idea is that Trichet did not do much during his stint at the ECB. Yet, he claims that without his actions, Mario Draghi's "whatever it takes" speech wouldn't have mattered much. 

To be fair, he deserves some credit. Trichet was head of the ECB during 2003-2011 and with the crisis beginning to show its teeth in 2009, the following table shows monetary policy actions since 2009 (even though the policy rate fell by more than 125 basis points in 2008 as a response to the sub-prime lending crisis).

As the reader may observe, the ECB's deposit facility rate fell dramatically in 2009, after new evidence on Greece showed that the country was sitting on a huge pile of debt; in fact both the main refinancing operations and the marginal lending facility rate were reduced during the year. This was actually more than most observers believed the ECB would do at the time. The rate remained unchanged during 2010 while, in an irrational change of mind, it was raised during 2011. As you may remember, the Decision to appoint Draghi was taken in June 2011, while the official inauguration date was in November 2011. Now, the only reason I am bothering you with the dates is that both the rate hikes in 2011 occurred while Trichet was heading the ECB. In fact, just 8 days after Draghi took over, the ECB rate was reduced by 25 basis points. 

In addition, have a look at the European Interbank Overnight (EONIA) Rate in 2010 and 2011: as it appears, the interbank cost of lending rose significantly in those two years (and only began to its fall after November 2011), at a time (after the first Greek PSI in late 2010 and just before the second PSI in Autumn 2011) when confidence about the banking sector had reached its nadir, with the whole situation forcing huge losses on periphery banks. During the same time, daily open market operations were reduced by approximately 38% from 775,559 to 483,141, while liquidity based on the Covered bond purchase programme more than doubled from 2010 to November 2011 (albeit in absolute numbers it was much less than the reduction of open market operations).

Source: http://www.global-rates.com/interest-rates/eonia/eonia.aspx

Yet, Trichet (or the ECB if you prefer) did something else in order to assist the then ailing European economy: bought large amounts of Irish and Greek government bonds as early as 2010, a policy which well continued in 2011. Had there not been the ECB buying bonds the crisis would have evolved much faster and with greater severity, as it has been a combination of both banking and sovereign trouble. Yet for some countries (Spain, Cyprus, Ireland), the former sector was the one which caused the latter to face problems, while for others (Italy, Portugal, Greece) it was mainly the latter which imposed its burden to the former. 

The ECB's reaction was one to "save the sovereigns" and somehow ignore the banks. This was justifiable at some point: the last three countries, of which Greece got the most publicity during the Trichet presidency, would have gone down spectacularly had the ECB not intervened. As for Ireland, the government was "forced" to guarantee the banks to avoid total collapse, thus forcing the ECB to "guarantee" the state. It goes beyond logic to suggest that the ECB did nothing for Ireland (or other countries in the EZ) during the crisis; yet it is equally illogical to suggest that the ECB did everything it could.

Summing up, the idea that Trichet did nothing, as well as the idea that his actions were what the Eurozone needed at the time are both nonsensical. Trichet should have lived up to his role as the ECB President and stand up against the PSI (if he was really against it). In addition, blaming others for their mistakes and not acknowledging that you could have done much more is not a sign of strength. Yet, the same holds for the MEP's: they are free to judge anyone for the outcome of their actions, but they should not forget that they are also liable for notorious inaction during the crisis. We all know that it's easy to judge in retrospect but it appears to be much easier to do nothing and then judge others about their actions.

P.S. A note to those who suggested that the PSI came back with a vengeance in Cyprus: the "bail-in" is much different from the PSI. In the latter the bank loses capital by experiencing losses in invested funds (in this case government bonds) while in the former it gains capital by effectively seizing deposits. And yes, the latter is better.

Is Europe Recovering?

At the time when the world's nations are wondering whether or not a military intervention in Syria is the way to go, the economy has managed to make it to the spotlight. It appears that good news are plummeting the market and judging from the table and graph above Europe is heading towards recovery. Or is it?

When the data are presented the way the are above, emphasis is given to the "X-month high" wording on the right. Yet, a more careful look in the manufacturing PMI shows something slightly different:

Even though the index appears to be increasing, this has not been because things are going better. It is because they are less terrible than before. In the words of Markit's Phil Smith (emphasis mine):

"The headline PMI continued its climb towards the 50.0 threshold as a slower decrease in new orders led manufacturers to moderate their reductions in output, employment and stocks of purchases compared to June. Although still some way off showing outright stabilisation in the sector, these latest data are at least a stark improvement from those observed at even the start of the year and bring hope that a recovery is on the horizon. “July’s decrease in factory employment was, as with new orders, the least marked since the start of 2010. This will have helped to relieve upward pressure on Greece’s unemployment rate which has already started to show signs of plateauing."

It is the economic analog of banging your head on the wall and then switching to banging it on plastic; you feel less pain and you are losing less blood than before, yet, you are still bleeding and you are still in pain. As Smith puts it, there are signs of plateauing. Nevertheless, this plateau has not been reached yet and we cannot be certain of when it will be.

In the optimistic analyses, it appears that we give too much emphasis on a single indicator. Consider for example, the unemployment rate: it has been rather stable during the summer, which means that either all EU countries have not witnessed a change in the unemployment rate (which is not true) or that it has fallen in some and increased in others. During the crisis, the drivers of unemployment have been the countries of South Europe, where it seems that, with the exception of Cyprus, unemployment was either stable or decreasing (by 0.1% at most) in July. Good news right? It depends. It may be that recovery is on its way, yet it may also be that we have had a surge in tourists in the highly seasonal South economies. The reader may object that the unemployment rate is seasonally adjusted; even so, a small deviation of 0.1% is something which no statistician would claim as possibly unaffected by seasonal effects no matter how good the adjustment is. The Greek statistical authority actually reports higher income from tourism in the second quarter of 2013 and thus revised its GDP growth to -3.8% from 4.6%. And just as any person who lives or has been to the South of Europe will tell you, the busiest months are always July and August.

On the other end of the spectrum, Cassandras are, as always, abundant: Ambrose Evans-Pritchard comments that the future may not be as bright as we think it will be, given that even if Europe recovers Germany will require a rates rise in order to stop overheating its own economy. Yet, the overheating of the German economy is not bound to happen even if Europe recovers. A rise in investment in the South would most likely equal a rise in exports in the North which would help boost the German economy. What the Germans should worry about is not overheating their economy but over-dependence on exports; a Eurozone recovery is something they should be looking forward to. What is more, Central Banks do not really influence policy that much: lending rates have already started increasing in Germany as discussed later.

Yet, Evans-Pritchard is definitely right on one thing though: oil prices have been increasing over the recent Syria turmoil and this is not a good sign in times of recession. High inflation in addition to extremely high unemployment could escalate to a situation much worse than the 1970's stagflation. Although the probability of an oil shock more than 100% is very low, it is still existent. As usual, political and military action in Middle East will define the price Western countries have to pay for their growth. In the same article, there is mention of M3 money slowing down to a 1.3% annualized rate of growth and the euro appreciating against the Japanese yen, the Brazilian real and US dollar. What is missing here is that these are the unavoidable consequences of non-EU policy: the extended QE policies in Japan and the US have forced their currencies to depreciate and the Brazilian real has actually been depreciating in general since 2012. Neither of those really means anything when it comes to recovery.

The most interesting topic Evans-Pritchard presents is "the rise in borrowing costs by 70 basis points (or 0.7%) across Europe". Although I wonder where he got the data (the FT's Michael Steen comments that lending rates have reached a two-year low in Spain and Italy whereas it the same appears to hold in France as well) the issue is the location of this increase in borrowing costs, as aggregate and averaged data are more often than not misleading. If countries like Germany and Finland are witnessing increased lending rate (just as the graph to the right indicates) then this is more good news than bad ones since the spread between EU countries is actually decreasing and it is the natural consequence of prosperous economies beginning to slow their growth rate. The decrease in of more than a percentage point in lending rates since 2012 is of tremendous importance both for SME's facing trouble as well as for future investment.

Unfortunately, after all this analysis and deconstructing of both the positives and the negatives, the question still remains: is the EU moving to greener pastures or will it remain in the land of austerity-driven recession for quite a while? The answer is that unfortunately we cannot know for sure until 2013 has gone by. PMI indices, euro appreciation and lower costs of lending are all signs of better days ahead, yet their effect is yet uncertain. If borrowing costs continue their fall and if the PMI continues to rise we may witness more growth than expected by the end of the year, and this is what most analysts expect.

Probably the most important issue here is that uncertainty has been lifted from the Eurozone. Although there are still fears of Italy and Spain defaulting, the probability is much lower than before; even in Cyprus, the bail-in has marked the end of uncertainty despite all the terrible consequences it has brought with it. Markets prefer bad news to uncertainty and this is what we are currently observing in the Eurozone. It is not that "Europe, it seems, has become anaesthetised to bad news," as Simon Tilford from the Centre for European Reform says. It is just that finance and economics are, by construction, optimistic fields. There is no point in planning for the future if you do not really hope, deep down, that it will be better than the present. And as already said, less bad news equals good news for some and they are right up to a point.

Personally, although I believe that the results of Q3 will further enlighten us on whether a recovery is on its way,  the situation is like a fire which is about to be put out in the near future; yet one for which the probability of rekindling is extremely high. The rekindling can come in various forms: oil shocks, bank failures, state defaults and even additional bail-outs. Yet, with the possible exception of a 3rd bail-out for Greece, everything else has very little probability; which does not really mean that we should rest assured that recovery is on its way.

Conspiracy Theories and the Eurozone

I do not like conspiracy theories. To be really honest I hate them. I believe that conspiracy theorists are those kinds of people who do not want to take responsibility for their actions (or their government’s actions) and think that this is all part of a massive hidden elaborate plan devised by -insert nation here- to control/take over their homeland’s economy/natural resources or whatever. Thus, anything they will do will be futile; all they can do is blame the one "responsible" for this as they sit around and do nothing. This kind of thinking I truly, honestly hate. 

However, lately I have been thinking about one. I am not proud to say it but I have. It all started when I began thinking about what they could do instead of the large haircut on Greek debt last year. If that haircut had not taken place the only country that would have been in direct danger from Greece would have been Cyprus, due to the explosive growth of its banks there. And even Cyprus wouldn't have been so worried then. Read more here.

What I have been thinking was this: Let's assume that policymakers in Eurozone are not stupid. Let's assume that what they have been doing has some rational reason hidden behind it. What were the consequences of their actions and who would benefit from that?

The first direct consequence would have been the fall of the value of the Euro. The following graph indicates this trend for the EUR/USD pair. (Graph was made by Yahoo!Finance)

As one may observe the value of the Euro versus that of the US dollar has declined dramatically of the past year and a half. Thus, it would mean that European products are now cheaper than they were 1.5years ago. Thus, more exports. This can be seen by the following graph (made by www.tradingeconomics.com)

As we can see exports began to rise after February 2010 and continue to rise to this day. (An examination of most EU countries individually would confirm this but to be honest I am bored to upload and comment on 20 graphs! I am sure you would be bored to read one article like that too.)

Thus the only conclusion we may draw was that the EU policymakers are deliberately keeping the EUR/any other currency rate down so as to export more. Any good news about the Euro economy would have as a result an increase in the rate and thus decrease exports. Thus the conspiracy theory would be that policymakers want to flood the world with EU goods (or maybe just German goods for obvious reasons. Wolfgang are you there?) and make us rich by large trading surplus; however not now but in a few years. It's a merchants world after all!

Or, they just make bad decisions. What do you think?