Monday, March 15, 2010

Weekly Hurriyet Column: A little EMFathy with Greece

Below is the unedited version of my column for this week. You can read the final version at the Daily News website, but since I have been editing my columns myself on the Daily News website since this month, you won't see much of a difference between the two.

I have to thank the Daily News editor-in-chief David Judson and loyal reader Sahika Balbay of Isbank of guiding me on writing on this topic. I began considering the topic for my weekly after a couple of email exchanges with Sahika and when David suggested I write on it, the issue was sealed. David's journalistic instincts have served me well in the past, as his suggestions have invariably been popular articles, and this time was no exception: It turned out to be one of the most popular and most commented articles (not just commentaries) that day.

Anyway, on to the article:


These days, I am trying to find a good lawyer so that I can sue German finance minister Wolfgang Schäuble for copyright infringement.

During my stint at D.C., I was scheming on setting up a competing monetary fund at the empty lot across the street from the IMF and call it the EMF, or Emre’s Monetary Fund. This ingenious idea never took off because somehow, I wasn’t able to solve the financing. Mr. Schäuble came up with the same acronym last week, suggesting a European Monetary Fund, which would act as a lender of last resort to cash-strapped countries such as Greece.

There are two ways to interpret this sudden outburst. First, you can see it as the latest attempt at showing a little empathy with Greece, now that the country has given in to pressure for more austerity. So, Greece’s misfortunes are not a result of its profligate government, but the evil rating agencies that had downgraded its government bonds so that they became at risk of not being eligible as collateral at the European Central Bank, or the immoral speculators that had bet against those bonds.

If you buy these arguments, you’d think that a ban on naked trading of sovereign credit default swaps, or CDS, as suggested recently by France and Germany, would prevent future Greek tragedies. After all, such a ban on investors who do not hold the bonds that they are insured against defaults would weed out the speculators from the risk hedgers.

While there is some merit to this reasoning, the CDS market is not as large or influential as it has been touted in the media. Besides, the direction of causality went from bond yields to their underlying CDS in the Greek melee. Then, supporters of the naked ban have yet to explain what they are planning to do about the jump in actual bond yields.

German Central Bank President Axel Weber’s suggestion that the European Central Bank could decide to lend against lower-rated bonds at more punitive terms is a step ahead of the naked ban, but it would simply be a temporary patch.

I doubt that Mr. Schäuble and the EU’s top brass are so short-sighted. They perfectly understand that Greece’s deteriorating public finances were a direct consequence of establishing a monetary union without an accompanying fiscal and political union. That’s why you see remarks on fiscal monitoring in between the lines of the EMF proponents.

And that’s precisely why the EMF idea is so difficult to realize. Not only the EMF could not be set up without a change to the EU treaty, member countries would not want to let go of their public finances, especially after they have already let go of their monetary policy and exchange rate flexibility. Setting up a cash coffer without an accompanying IMF-like mechanism would then be an open invitation to all countries to go on a spending extravaganza.

But the Greek empathizers are right to note that the issue is not really about the irresponsible Greek government. Argentinean economist Guillermo Calvo once said that we don’t know much about economics other than accounting identities, and the accounting identity I have in mind is that a country current’s account balance is equal to its private saving investment and fiscal balances.

As FT’s Martin Wolf recently noted, this is really a crisis about the large imbalances inside the EU when you look at it through that lens: The Greeks and others were able to spend so much only because the Germans chose to spend so little. And while no one could deny that Greece ran irresponsible fiscal policy for many years, the story was one of the profligate Greek consumer and her frugal German counterpart, at least until recently.

Then, maybe, the Germans need not look far away for a fix to EU’s woes, after all…

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