Boone and Johnson on the Eurozone Crisis
By Arnold Kling
Peter Boone and Simon Johnson have what written what I believe is the best analysis of the Eurozone crisis, which on this blog I refer to is as the Kipper- Und Wipperzeit. Thanks to Timothy Taylor for the pointer.
I will tease you with some excerpts from Boone and Johnson, but you should read the whole thing.
The euro crisis is not under control. Deep structural flaws have become apparent–particularly the extent to which moral hazard has underpinned credit flows within the euro area. Ending this moral hazard will not be easy, particularly as European decision-making structures are struggling to find a comprehensive approach.
…Market prices currently imply an 88 percent chance of default in Greece within five years More worrying is the rise of Italian CDS prices to near-record levels on July 11. These now imply a 25 percent chance Italy will default within the next five years.
…In France, Italy, and Germany, the largest two banks alone need to roll over 6 percent, 9 percent and 17 percent of national GDP in debt, respectively, within 24 months. This compares to just 1.6 percent of GDP for the largest two banks in the United States.
…Goldman Sachs reports that the exposure at default of the European Bank System to the GIIPS sovereigns (Greece, Ireland, Italy, Portugal, and Spain) equals 1.5 times their tangible equity.
…The much larger financing needs come from capital flight. In Ireland the two leading banks lost €65 billion in deposits from the end of 2008 to the end of 2010–equal to 52 percent of Irish gross national product. Similar deposit losses have occurred in Greece. As bond yields rise, the local banks tend to buy, because their futures are inextricably tied to the survival of their sovereign. Foreign institutions tend to sell bonds back to the local banks of the government that issued them. Finally, corporations and households tend to save outside their local banks, and foreign bank branches tend to reduce the size of their balance sheets in troubled nations.
…the Bundesbank is the largest creditor to the system, being owed €340 billion, while the central banks of GIIPS are the largest debtors. The total credit to GIIPS is €336 billion, which is more than the combined value of all the bailout packages to Greece plus the European Financial Stability Facility, the rescue fund backed by euro area nations. The credits are provided with no approval required from national parliaments or budgets, and there is an implicit assumption that all will be fully repaid.
…If some central banks decided they would no longer accept claims from another central bank–let us say, hypothetically, the Bank of Ireland–this would effectively end the euro area. If euros held in Irish banks become less useful than euros held in German banks, the price of the two will diverge.
…each troubled nation will need to end its budget deficit quickly. The most direct route, as discussed above, is to embark on significant public sector wage and benefit cuts that bring the primary balances into substantial surpluses.