How much of an ECB guarantee would be needed?

by on November 19, 2011 at 3:03 am in Economics | Permalink

Here is one recent report (insightful throughout, FT link):

But the scale of the problem is bigger than in 2008. Mr King notes there is $3,000bn of government bonds trading with spreads of more than 150bp to German Bunds. There were only $2,000bn CDOs outstanding at the peak.

The population of Germany is about 81 million, if you wish round that up to about 100 million, if you include some of the smaller Triple A countries.  In other words, that is a guarantee of $30,000 per German, or $120,000 for a household of four.  Note in passing that an ECB guarantee either requires recapitalization of the central bank or a higher rate of inflation, unless you think the whole thing is a self-sustaining free lunch and all the liquidity problems would vanish (unlikely, at this point).  In any case a guarantee has to at least put resources on the table.

As of 2007, the median net wealth in Germany was about 15,000 euros per person, or well under the proposed guarantee, the exact figure depending on how you make the exchange rates over 2007-2011 commensurable.  The mean net German wealth was 88,000 euros at that time, so maybe you could think of the guarantee as mostly backed by the wealthy.

Or maybe you could think that the numbers just don’t add up.  Germany itself has a public debt to gdp ratio of about eighty percent, demographics are unfavorable, and taxes are already high.

Keep in mind I was sampling the stock of extant debt from the weaker countries and not even considering whether the future flow of debt would require a guarantee.  I readily grant that I am mixing stocks and flows incorrectly, but I was trying to be generous to the possibility of a guarantee.

Addendum: Via Henry, here are yet further reasons why Germany will not bail out the periphery.

Firat Uenlue November 19, 2011 at 4:12 am

Being a German with foreign parents I have had the opportunity to get somewhat of an insider’s and outsider’s perspective. A year I wrote that there was no way we’d bailout Greece or risk inflation because the problem itself was simply too large and that in knowing that politicians wouldn’t even be so daft as to consider it. Well, we haven’t printed because that’s been a German taboo so far, but bailouts had been a taboo once as well. You have to understand that the current leadership and many Germans value the integrity of Europe beyond anything, they would even sacrifice their own country for it. Talking with Germans I don’t get think they understand the concept of ‘national interest’ in the same way Americans or Chinese do. To the decision-makers ‘national interest’ is tied up with Europe. One of the leading magazines, Der Spiegel, recently had an article why Spain’s government dynamics were supposedly better than Germany’s. In what other country would people basically turn against their country to support another one in the name of regional integration? If you look around you can see that the groundwork is being laid to hammer into German’s minds that a) it’s a liquidity crisis and if only the ECB intervened all would be fine and b) that printing money doesn’t equal Weimar. Merkel has been saying for weeks the same thing: ‘if the Euro fails, Europe will fail’. They’d rather print and find excuses for it rather than see the Euro collapse.

It now comes to this, German inflation-angst versus war-guilt and the sheer will to keep the Euro and thus Europe intact. My money is on the will to keep the Euro intact. Yes there’s a way to keep Europe and the EU working without the Euro but try telling that a German…

There’s two caveats though. One is that markets move faster than the Germans are willing to let the ECB print. Secondly, Germans don’t seem to understand that reforms, even if succesful, take time and market’s won’t wait long enough. It is simply absurd to claim that things will be in the markets once reforms are pushed through. Far from it, reforms take time and austerity is going to bite into growth initially. My prediction thus, Germans will let go of their Weimar-induced inflation-angst and let the ECB print to keep yields at a punishment level of around 6%. Obviously this won’t be much of a help without guaranteed future transfer payment because the competitiveness gap within the Euro is simply too big at this moment, the necessary deflation which is needed in Southern economies can’t occur due to the high debt stock. But that’s a problem for another day.

msgkings November 21, 2011 at 4:47 pm

Good post. I read (and agreed) that the ECB is really trying to do one of two things. Either they are holding out as sternly as they can to force painful national reforms before turning on the money hose, or they really really intend to never turn it on at all.

If it’s the former, that’s a high stakes game of poker they are messing with. If the latter, the Euro is obviously toast.

But let’s be clear, the Euro failing or shrinking in membership isn’t some kind of world ending event. It will be for many European and some non-European banks. but the world’s people will continue eating, working, having kids, and buying stuff. We didn’t even have a Euro until Jan 1999 and the world somehow managed to function.

Someone from the other side November 19, 2011 at 5:10 am

Germany cannot afford to have the Euro fail as that would mean making its industry uncompetitive due to the appreciation that would ensue for its replacement currency. Printing on the other hand may actually help them…

Rahul November 19, 2011 at 2:52 pm

Wouldn’t subsequently inflating a Germany-specific currency be a better option (for German interests) than inflating a EU-wide Euro right now?

NAME REDACTED November 20, 2011 at 7:29 am

Nonsense. Germany was growing well (although high unemployment during unification) before the euro and they will do well even when the euro is gone.
Germany doesn’t need the euro, the euro needs Germany to give it credibility.

JWatts November 21, 2011 at 9:32 am

+1

Zach November 19, 2011 at 5:36 am

The German side of the bailout argument is interesting. There’s very little doubt that
1) They don’t want to bail anybody out
2) Nobody can make them bail anybody out
3) There’s very little they want enough to make for an equal exchange

on the other side, there’s the consideration that

4) They’re invested in the status quo, and would suffer at least somewhat by a breakup of the Euro or the European Union.

Given those interests, it seems like the best strategy would be to slow-walk everything, be very slow to disperse money or guarantee debts, and basically hold debtor nations’ feet to the fire. That’s not going to make any friends, but it’s hard to see what they gain from being too eager to guarantee other nations’ debt.

Bill November 19, 2011 at 5:19 pm

I like the use of the word “bail out” in creditor/debtor relations. Usually if you are a creditor and your debtor doesn’t have the money, you lose.

You can also use the word ‘haircut’ as applied to the creditor, and ‘hair shirt’ as applied to the debtor, depending on their relative bargaining position.

foosion November 19, 2011 at 6:23 am

Total US bank deposits are reportedly approximately $7 trillion. Consider what the per household FDIC liability is.

Much of the periphery has a run-on-the-bank liquidity problem, not a solvency problem. An ECB guarantee would solve the liquidity problem. There’s no real chance Germans would be out of pocket for the entire amount of the guarantee.

Austerity slows growth, making it more difficult for the countries to pay down debt. Debt as a percentage of GDP goes up as GDP goes down. Look at the UK for an example of failing austerity.

And no amount of austerity is enough to stem a market panic.

Bill November 19, 2011 at 8:44 am

Agreed. When you state some number of good accounts, and obligations that will be paid back, and include that in the universe of all obligations, you get a rediculous number like Tyler had, and then you apply that to every person.

But, don’t think this only Tyler who plays this game: we do it for our national debt (so much per person, nevermind we don’t offset assets or future income over time, or factor in economic growth, etc.). In Tyler’s example, note it is only Germans, and not others, who are at risk, and that only wealthy countries, but not indebted, would bear a burden.

When I saw the post my only thought was: This argument is trying to persuade me with bad economics and bad thinking.

JWatts November 21, 2011 at 9:39 am

“Much of the periphery has a run-on-the-bank liquidity problem, not a solvency problem.”

No, that’s an oversimplification the other way. Europe in general has a slow growth combined with high debt problem. They may not be insolvent, but their head isn’t very far out of the water. (i.e. slow growth). Easy money and government spending haven’t created high growth over the last 15 years, they won’t suddenly create high growth now.

I agree that severe austerity would be bad, but a path to a balanced budget is essential. And the ‘balanced’ part has to recognize the very high amount of off the book liabilities. So some kind of austerity is essential. Obviously, cutting the parts of government that are least likely to encourage growth, while leaving the other parts of government intact would be the optimal approach.

Tomasz Wegrzanowski November 19, 2011 at 8:22 am

This is all nonsense. Central banks only need to threaten to print more money, which wouldn’t even increase inflation that much since NGDP is so much below trendline. Nobody’s personal wealth would be at stake, and inflation would increase only slightly if at all.

Not that there’s anything wrong with 5%/year inflation whatsoever.

Tyler Cowen November 19, 2011 at 8:41 am

It is still redistribution away from Germany…

Bill November 19, 2011 at 9:59 am

Any change from the status quo other than some form of mutual guarantees with others is likely to be a redistribution away from Germany: a breakup means a high bund, less exports; staying in the eurozone with others defaulting means German banks get support (which is probably the measure of Germany’s exposure).

All alternatives are a redistribution away from Germany.

Whoever said you could keep a status quo.

NAME REDACTED November 20, 2011 at 7:30 am

The status quo is also redistribution away from Germany (and towards France).

Steven Kopits November 19, 2011 at 9:42 am

Great comment!

jk November 19, 2011 at 10:02 am

“It can’t happen in Germany.” “It’s the irrationality of the markets.” Maybe…

The EU should give up the facade of a government, pack up Brussels, and move to Berlin next to Merkel’s office (acutally a sub-wing of her office). They can cut out the decision layers, be honest on who is in charge, submit to who actually has influence and makes stuff happen thus once again fulfilling the German (and French) tendency to dominate Europe (in a non-Godwin sense).

Merijn Knibbe November 19, 2011 at 10:30 am

Hmmm. Total Eurozone government deficit in the second quarter was 3,7% of GDP… Not seasonally adjusted, I do have to admit. But wasn’t this 9 or 10% or so in the USA and the UK? The EZ-problem is not the level of debt. The EZ-problem is not government deficits. The EZ-problem is 24% interest rates on Greek debt. And 7% for Spain and France and Italy and whatever.

Now, that’s a redistribution away from Greece and Spain and France and Italy…

Paolo November 19, 2011 at 11:40 am

Good comment. The european DEBT (???) crises will end with a ECB intervention US-UK-japan-Swiiss-style (80 pct probability) or with Germany going out of Euro (20 pct but for them will be like losing the III WW). After that the crises will move to what created all mess since 2007: the US DEBT and the Us unbalancing. The US economists and bloggers never talk about this; is it just a Kahneman limit to predict or they are simply biased? I would say the second

Bill November 19, 2011 at 12:08 pm

All we have to do is let some of the Bush tax cuts expire ($3.7 billion over next ten years), cut military spending, close some loopholes, cut ag support payments, etc.

Paolo November 19, 2011 at 3:09 pm

Not so simple for an economy which is more or less 70 pct consumptions and basically in a fixed exchange system with its more rilevant creditor. (Sound familiar? Like Germany with peripheral european countries)

Bill November 19, 2011 at 5:20 pm

???

jk November 19, 2011 at 12:48 pm

Schadenfreude on top of schadnefreude, meta-schadenfreude? No just nationalism, here’s to hoping that the home team doesn’t fail. After all, the Eurosceptiks are always the crazy guys right?

David Pearson November 19, 2011 at 10:35 am

Tomacz writes, “which wouldn’t even increase inflation that much since NGDP is so much below trendline”

This statement is wrong, and dangerous. First, the output gap does not constrain inflation in countries that monetize deficits: Latin countries offer plenty of examples. Second, if it wouldn’t increase inflation much, what effect would it have beyond a liquidity one? In other words, if Italian NGDP growth remains at 2-3%, how will it pay its debt to the ECB? I think it would eventually default, just as Argentina defaulted to the IMF, its “LOLR”, in 2002.

You either have inflation, in which its difficult to control, or you don’t have inflation, in which the central bank hasn’t accomplished much. This fine-tuning “middle ground” that asset purchases can solve the problem without inflation is the least likely scenario.

Finally, ECB asset purchases are fiscal policy at this point. The same could be accomplished if the ECB bought newly-issued “Eurobills” (s.t. Eurozone obligations), and the EU used the proceeds to buy periphery debt. What? The EU doesn’t want to issue Eurobills? Right, so its a fiscal, not monetary, failure.

Yancey Ward November 19, 2011 at 11:26 am

Note in passing that an ECB guarantee either requires recapitalization of the central bank or a higher rate of inflation, unless you think the whole thing is a self-sustaining free lunch and all the liquidity problems would vanish (unlikely, at this point). In any case a guarantee has to at least put resources on the table.

The inflationists see a free lunch. Inflationists always think this- always. And note how the arguments always dovetail with mercantilist arguments for Germany allowing it.

Real resources will have to be transferred from Germany and the other, stronger economies. The inflation argument always is an attempt to obscure this reality.

dearieme November 19, 2011 at 11:42 am

It ain’t a liquidity problem, it’s a currency problem. The BIGPIS are using Euros and are really ill-suited to that. They need a change.

(N.B. BIGPIS = Belgium + PIIGS.)

Dredd November 19, 2011 at 12:04 pm

According to the latest census data, and analysis of it, we have 100 million people in the USA living on the verge of financial oblivion.

That is a greater number than all of Germany’s population.

Bill November 19, 2011 at 12:27 pm

You break it, you own it.

Or, if you are Germany, if you stabilize it, you own it.

You can see this coming if you look at some of the German newspapers and their discussion of how Germany should use this crisis an opportunity to integrate the EU more, and exert greater control:

http://www.spiegel.de/international/europe/0,1518,797626,00.html

David R November 19, 2011 at 7:56 pm

There are a number of science fiction novels where winter lasts for centuries. Europe may be beginning to ape this genre of fiction.

Floccina November 20, 2011 at 9:26 pm

due to their having declining populations perhaps the best thing that they can do is agree to write down the debt.

msgkings November 21, 2011 at 4:53 pm

THIS!

Declining/aging populations are the real story here, not the Euro. Break up the Eurozone and the big problem is still there.

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