Wednesday, September 28, 2011

Leveraging the EFSF is attractive, but risky

by Gavyn Davies

Financial Times

September 28, 2011

When the idea of leveraging the European Financial Stability Facility to increase its firepower was touted as the solution to the European sovereign debt crisis at the International Monetary Fund meetings last weekend, markets rallied sharply. They saw this (rightly) as the first sign of a policy initiative which might actually be large enough to get ahead of the deteriorating crisis. But I commented here on Sunday that there was no real indication that Germany was ready to embrace the scheme and, sure enough, Wolfgang Schäuble, finance minister, yesterday described the approach as “a silly idea” which “makes no sense”.

Germany’s public opposition to increasing the size of the EFSF may be partly tactical, given tomorrow’s key vote on the fund in the Bundestag. But it is also based on a crucial sticking point. The strong economies fear that increasing the size of the fund would result in them losing their own triple A status and they have consistently given a greater weight to these costs than to the less certain, but potentially much larger, costs of a euro breakdown.

Therefore the key question is whether the EFSF leverage plan would overcome this obstacle. In my view, it does not, but it changes the trade-off. A leveraged EFSF would increase its chances of solving the crisis, but only at the risk of increasing the long term fiscal transfers which Germany and the other strong economies would have to make if things went badly wrong.


1 comment:

Chandra Sainanee said...

Here is an apparently naïve looking solution, which will work as a magic wand to get Greece out of the debt crisis within a day!!!
All economists agree that if Drachma was to replace EURO, highly devalued, it would solve many problems but will create dominos effect in Europe - and globally AND will also make the debt refunding impossible. This solution eliminates the two risks.
Hint 1) Why & How to devaluate EURO in Greece alone without quitting EURO and without increasing the debt.
Hint 2) The root cause of Greece’s problem lies in French and German Economies.
Over the last ten years, the buying power of ONE EURO within Greece for goods and services is, and has been, almost twice of that in Germany, France, Holland etc. This has resulted in more loss/deficit in taxes (Income tax, VAT, company tax) in number of Euros collected as taxes by the State. In other words, the inflated salaries and goods prices in the Northern Member States, which imply lower buying power of the same ONE EURO, have helped such Northern Governments to collect significantly more taxes. The lack of tax collection in Greece due to the black economy is not as significant as the lack of taxes due to the strength of EURO in Greece!
The overnight solution is therefore:
1) Increase all private sector salaries in Greece by 35%
2) Increase all public sector salaries by 30%
3) Allow price increase of goods and services based upon a voluntary calculation of the increase due to salary component (obviously limited to 35%) based upon auditable results of previous year’s Accounts of ‘Salaries vs. Sales’ of any entity.
4) Give Government incentive for exports to companies, equivalent to the increase in Salary component by 35% for any goods actually exported. This avoids penalizing exports.
What will happen?
1) Inflation will be triggered in Greece bringing the prices of Coffee/Bread/Restaurants/ to similar higher levels as in Germany/France/Holland. The EURO of Greece will no longer have a higher buying power than in other countries.
2) Public sector will gradually suffer a 5% loss in buying power compared to the private sector workers, within a period of 6 to 12 months. Indirect and gradual non--imposed austerity.
3) The Taxes received by the government will be at least 33% higher without counting the effect of the additional spending spree due to an artificial salary increase – more than expected but natural. This will have small additional inflationary consequences but will create employment.
4) The Black economy will be reduced due to Export incentives based upon true official salary paid.
The accumulated deficit will be cut by half becoming less than 60% of GDP within 3 years and it will be visible on day one – getting Greece back to AAA Credit Rating now!
With no other solution in view and time running out – this is a guaranteed solution but requires the right Will and tremendous political Courage.
Oh Papandreou! Rise to the occasion at the eleventh hour.