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.
READER COMMENTS
Patrick R. Sullivan
Aug 5 2011 at 12:39pm
I’ll bet that tasted like vinegar.
Thucydides
Aug 5 2011 at 4:41pm
It is not clear to me how the European central bank clearing system results in interbank balances when there is capital flight, say from Ireland to Germany. Why should someone in Ireland moving a bank balance to a German bank result in this?
Daublin
Aug 6 2011 at 6:16pm
Thank you for the very good read. There are many bloggers commenting
on individual issues, so it’s helpful to have such a general overview.
One reaction I have to the overall arrangement is that it seems to
require energetic, sophisticated, and intelligent effort to make the
Euro and its associated banking system hold together at all. Surely
there is some simpler mechanism to achieve a stable currency and to
allocate the penalty for bad loans onto the people who take part in
them.
In the current Euro, the member nations are facing existential risk to
their financial systems. I would think such a risk should be opposed
with the same vigor one would oppose enemy troops lining up on the
border. Yet, the member nations seem totally committed to maintaining
this risky arrangement.
This must sound naive, but what is the benefit of the Euro that makes a risk seem so palatable? Is there anything more to it than the populist good feeling of being part of a bigger, America-like union?
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