May 17

The EUR exchange rate and the 750 billion bailout package

By Ivo Sokolov Economics and Business, Politics 4 Comments »

You don’t need to be a tabloid nowadays to err on the populist or sensationalist sides when writing about the “Eurozone umbrella plan”. I do understand that the deep structural problems some Eurozone countries currently face call for a more critical writing style. However, some parallels drawn in popular media in regard of the falling Euro exchange rate are simply technically wrong.

It should be obvious by now that both many of the foreseen measures in the umbrella plan, as well as the current monetary policy and actions of the ECB lead in fact to devaluation effects (i.e. due to longer term low-interest rate prospects on the one side, and ECB measures such as additional financing facilities on the other side). Thus, saying that the Eurozone “bailout package” did not help “stabilize” the EUR/USD exchange rate is not correct. If anything, the umbrella plan not only did help (or so we hope) buy more time for EU-member states with deficit issues to deal with their fiscal and structural problems, it also brought about a devaluation that is more likely to help, rather than harm the EU economy in my view. A weaker Euro will enable Germany to achieve even stronger short-term growth, given the distinctive export nature of its economy. Smaller side effects may include a boost in inbound and inward tourism, especially helpful namely for the southern European countries in need. I would not go that far to call it a breath of fresh air, but a devaluation of the Euro was somewhat due, taking into account over-performance against the US dollar in the recent years.

It is however still noteworthy to mention that, seen as a whole entity, the European economy (including the other EU currencies) is pretty much self-sufficient. Exports and imports each have less than 20% share of the combined GDP. Hence, generally a slight Euro devaluation should not have major effects on both the inflationary and the export sides in the monetary union. Indeed, looking at the EU as a whole, many of the challenges countries such as Greece, Portugal or even Spain now present politically to the Eurozone are somewhat balanced out, had the EU been a single country. After all, structural differences aside, California’s state deficit is (as a problem per se) not much different than Greece’s (meaning governments over-borrowed for many years) but the resulting rhetoric is very different — a EU-member country is (not yet) a US member-state.

Well, that’s enough for far-fetched remarks. We shall see how the markets react to new government debt issues from the PIIGS countries in the coming months. My personal opinion — that ought to be enough to secure reasonable borrowing rates from the markets.

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Jan 16

The Euro in Bulgaria in sight

By Ivo Sokolov Economics and Business, Politics No Comments »

Welcome to the first post in 2010! After having my blog (WordPress 2.8) hacked, I am happy to be reporting online again. I feel sorry for the poor soul that took the time to bring this website down for a couple of days, yet nevertheless I feel somewhat honored by the attention that I am receiving.

I would first like to comment on a Wall Street Journal article from Jan, 12th. I hold the concerns of Bulgaria’s prime minister Boyko Borisov that public debt surges in Greece (and to a lesser extent elsewhere in Old Europe) would have repercussions for Bulgaria’s euro-zone for very well grounded. The realistic achievement of a balanced budget in 2010 would be a huge success amidst a pile-up of political and public policy disappointments of the government led by Borisov. This success alone may however not suffice for a euro-zone membership. I am a big proponent of an early euro-zone entry, but still, the overall costs of integrating Bulgaria at this time may be higher than expected. The EU/ECB will have to carefully sort out whether the benefits for the added stability in Bulgaria would outweight midterm costs and lead to stability loss for the euro-zone as a whole.

Below I am posting an excerpt from a seminar paper that I wrote as an undergraduate which dealt with Bulgaria’s currency board on the way to the euro-zone:

…
Mundell (1961) et al formulated labor mobility, the degree of openness and economy diversification as the basic requirements for participation in a single currency area. [..] According to his analysis single currency areas rely on similar levels of price stability where a single monetary policy would theoretically suffice for all. His work had helped lead to the creation of the Euro, which according to him is “a great step forward” and “a catalyst for international monetary reform”. However, some of the requirements for a single currency area to work (such as the common U.S. Dollar for all 50 states) that Mundell has postulated such as labor mobility and indirectly language barriers and housing markets flexibility do not yet fully apply for the newest EU-members such as Bulgaria. Hence, even in basic theory, notwithstanding all common sense reasons and the positive public opinion to join the EMU, some contra-arguments exist in regard of the ability of the newly joined the EU “immature” Bulgarian economy to fight asymmetric shocks. Still, there is an overwhelming amount of positive effects that make the adopting of the single European currency unambiguously attractive, especially in a credit crisis with inherent refinancing problems.
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Summarized in theory, benefits of euro-zone integration include the elimination of exchange transaction costs and exchange rate volatility, removal of payment obstacles to trade, prevention of competitive devaluation and speculation, prevention of extremely high interest rates that hinder economic growth when countering a currency speculation attack. [..]
…

I remember that in April 2009 the Financial Times quoted a non-disclosed IMF report, urging for unilateral euroization because “to countries in the EU, euroization offers the largest benefits in terms of resolving the foreign currency debt overhang, removing uncertainty and restoring confidence”. This assessment certainly still holds true and I hope that the severe public spending slashes actually do help put Bulgaria in ERMII soon enough.

Talking about spending cuts, I fully support Simeon Djankov’s actions for many reasons. Bulgaria’s economy has to be painfully restructured to rely much less on government spending — government projects, orders and the like. Apart from infrastructure projects the government should not be the main contractor and provider of business that companies are on the lookout for. And yes, taxes are low but I can’t help but quote Milton Friedman here that “if you receive more revenue by cutting taxes, you aren’t cutting taxes enough”. Thus, if Djankov is cutting spending while keeping taxes low — well, he can’t do much wrong. The whole polemic of an ultra large intra-company indebtedness that circulates in the media in Bulgaria is in my opinion overrated and things will eventually settle back to normal.

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Dec 09

Greece high on deficit, got downgraded, now what?

By Ivo Sokolov Economics and Business, Politics 5 Comments »

Emil A. Georgiev wrote a comment in my blog that I think entails a new post in reponse. He said:

I believe the Emirates will make it, but what do you think about Greece – a member of the Eurozone?

Yes, Greece’s budget deficit, rating downgrades and potential problems with their sovereign debt rollover are somewhat alarming. The problem is not that they do not have the money to repay that debt (of course they don’t) — the problem is that they are supposed to refinance themselves from the market. And as the market lends only to prudent borrowers, at a 12,6% deficit Greece may not be considered an eligible one.

Yet when it comes to a Western European, Eurozone country make no mistake — that debt will be underwritten no matter what. On the one hand, the effects of a potential Eurozone sovereign default will definitely be Lehman-like, i.e. the systemic relevance of that sovereign default is paramount. On the other hand, the surplus liquidity that the ECB seems to be slowly and deliberately retracting (e.g. their announcements on the ‘enhanced credit measures’ from last week) can and will be channeled elsewhere when needed. They do not even have to go great lengths to inflate away that debt.

In the end of the day, no one will allow a small and highly leveraged country of such systemic relevance to go under. Not only Greek’s government, but also the whole Euro currency union is only as good as its credibility. The rating agencies’ response and ultimately the higher cost of borrowing will have to be sadly borne by the whole Greek nation. Putting a higher price tag on future borrowing for the whole Greek economy out of rating/market necessity will act more disciplinary than any legal constraints Brussels might impose on Greece. After all, if they had been following the Eurozone 3% GDP deficit guidline figures, they wouldn’t be in the mess they are today. I do expect though that there will be significant pressure on Greece to cut its public spending, should the EU/ECB really step in to bail out the Hellenic Republic of Greece.

By the way, what this also re-translates to is that Bulgaria’s aspirations to ERM II could be put to a halt for the forseeable future. Joining the EU once is a good deed, but entering the monetary union now might actually go far beyond the official Maastricht criteria. Thus, even if we consider that in a semi-deflationary environment Bulgaria meets all three criteria with a balanced budget (close but under the 3% mark), low inflation (to be in the top 3 lowest EU-wide if I recall correctly; seems somewhat achievable now) and low public debt (Bulgaria’s is way below the maximum of 60% of GDP required), Bulgaria might still not make it to the Eurozone out of political and country risk reasons. Even without the infrastructure and social expenditures of Greece.

In a nutshell, Greece will not default. As the saying goes, if you do not repay a € 1.000,- debt you have a problem; if you do not replay a € 10 million debt, the bank has a problem. In this case this bank is the ECB and the responsible account manager is the EU. They will surely get a hold of the situation, yet the “little Dubai” effect and the bad aftertaste of a popped property price bubble will continue to linger not only on Bulgaria and Greece, but also on any country that leveraged itself mostly through property sales, rather than industrial output in the recent years (such as Spain).

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