Eurozone to issue yuan bonds???

Worthwhile Canadian Initiative is not normally a blog for very short posts. We try to be a bit more analytical. But there's really not much one can say about this idea reported in the Telegraph, other than: this is really stupid. The whole Eurozone problem is that each Eurozone country was issuing bonds in what was effectively a foreign currency, and so it lacked an effective lender of last resort. Now, if the Telegraph is correct, the Eurozone as a whole is planning to repeat the mistake, and become just like Greece.

Comments

[Mandos]

The whole design of the Euro was intended to bring about a political fait accompli, where the public would be forced to accept a particular arrangement lest catastrophe ensue. Lo and behold, we have reached this point, but it is still politically unsupportable. So the attempt to thwart/direct democratic procedures has, at least at this point, not succeeded.

[Lars Christensen]

Or maybe the plan is to merge into the Yuan and let the PBOC take the loses;-)

[George J. Georganas]

Yes, a truly stupid idea.
But, Mandos, is not any fiat currency an essentially undemocratic device ? Why, even gold has to be officially weighed and stamped. "Democratic" barter just doesn't cut it, it seems.

[Ian Lee]

I agree with everything you said. But is this not an additional signal of the desperation of the European leadership?

By way of explanation, we now know the answer to Henry Kissinger's famous question when he was Secretary of State: "who do you call in Europe if there is a problem?" - acidly highlighting that if everyone is in charge, then no one is in charge.

But 40 years on, we have the answer. The Chancellor of Germany has emerged - because of the crisis - as the de facto President of Europe while the President of France is the consigliere to the real EU President (German Chancellor) and all the other European Presidents and Prime Ministers have been downgraded to mere provincial premiers.

What Germany failed to achieve in two world wars- the domination of Europe - has now been achieved through the force of competitiveness. My late Brit father, an RAF bomber pilot in WWII, would not be surprised as we lived in Germany in the late 1950s during the extraordinary Marshall plan reconstruction and again during the entire 1980s and witnessed the unbelievable discipline and focus of the Germans.

We also learned this week the answer to the question why these countries joined the Euro. As I argued in my paper to the EC sponsored conference on the eurozone last August, the Germans entered on the assumption they would ""Germanicize"" the Europeans to become more frugal, fiscally responsible and disciplined - Bundesbank values - while the Europeans wanted to ""Europeanize"" the Germans by allowing the southern countries to join and benefit from German bund borrowing rates.

Buried in the Summit Communique last week was the announcement that the troika will actually take over the administration of the austerity and privatization programs in Greece - from the Greek bureaucrats - as they do not trust them to execute. Per Spiegel and the Telegraph, this astonishing demand for the abdication of Greek sovereignty came directly from the Germans.

Equally clearly (per Pritchard, Wolf et al), the Germans will not support fiscal union nor Eurobonds nor ""transferunion"" nor ECB as lender of last resort nor indeterminate bailouts of southern Europe.

Germany will support austerity as the only route for these countries to regain competitive balance (estimated at 35% gap) with Germany, Austria, Netherlands et al.

Alternatively, the GIPS countries can refuse to adopt the austerity program, and thereby be denied further assistance - effectively forcing them out of the eurozone.
The EU leadership realize this and are desperately seeking a "third way" (instead of austerity and restructuring or exit from Euro) - i.e. are seeking a bigger banker, a bigger "sugar daddy".

And that would be China. Drowning men grasping at straws ...

[Min]

"The whole Eurozone problem is that each Eurozone country was issuing bonds in what was effectively a foreign currency, and so it lacked an effective lender of last resort. Now, if the Telegraph is correct, the Eurozone as a whole is planning to repeat the mistake, and become just like Greece."

Oh, I thought that the Eurozone lacked a lender of last resort because the ECB was not given that power. But if Europe becomes a tributary of China, couldn't the Chinese bail them out? Nin hao, European Imperialists!

;) ;) ;)

[Ian Lee]

Nick - one more quick point that I should have made.

Contra Krugman and the myriad number of critics who condemn the Germans for "not realizing that austerity will only produce deepening recessions, make the problem far worse and why don't the Germans understand basic economics" etc., it is clear that the Germans understand this well.

It seems pretty clear the Germans have come to the decision and determination that they are not willing to become the de jure or de facto guarantor for all Europe or even for all of the Eurozone.

Restated, they will support the Eurozone on their terms which they believe are the only policies and terms that are effective in the long run - even if it causes a great deal of pain and suffering in the short to medium term - but not on any terms simply to save the euro at all costs. After all, the Germans have very deep and extensive experience in pain and suffering - albeit often due to their own bad behaviour in the past - and yet they survived and prospered mightily after two wars of unimaginable destruction.

(I was in Gdansk a few years ago teaching and my students took me to the war museum which showed photos of incredible destruction - bombed flat with almost no buildings standing - similar to photos of Hiroshima. I remarked that the Germans did a really good job blowing the place up and my students noted with a faint smile, no it was the Brits and the Americans as this was the submarine pen of Danzig).

Properly decoded, the Germans are saying yes to Eurozone and euro - IF and only if - the countries that need assistance are willing to adopt and execute brutal austerity to eliminate the competitive imbalance between north and south. And if any of those countries decide that the pain and suffering of austerity is too much, Germany will facilitate that country's exit from the Euro.

I argued in my paper last year that once the Greeks finally really realize that the Germans are really serious and there is no more borrowing at German bund rates and there really are no more bailouts, the Greeks will eventually collectively conclude there is no national interest in remaining in the Euro and exit to the drachma - which will collapse by 50% to 70% and then seek IMF support, as did Argentina, Mexico and other independent countries during currency crises.

The shameful behaviour and disservice to the Greeks has come from FT and European leaders who continue to argue for policy options that the Germans have flatly publicly repeatedly rejected, thereby giving faint hope to desperate Greeks that the Germans will change their mind at the 11th hour - when the Germans will not.

[Lars Christensen]

Nick, I call this the "China Bluff". Iceland tried a similar thing, but the Icelandic version of the "China Bluff" involved Russia instead (http://marketmonetarist.com/2011/10/29/the-china-bluff/)

[Max]

The French finance minister (now head of IMF) suggested after the Japan earthquake that Europe could help Japan by buying Japanese bonds.

But being generous, maybe this is not another instance of monetary stupidity but an effort to influence German opinion.

[Min]

Ian Lee: "{The Germans} will support the Eurozone on their terms which they believe are the only policies and terms that are effective in the long run - even if it causes a great deal of pain and suffering in the short to medium term. . . ."

OC, that is somebody else's pain and suffering. Par for the course, it seems. :(

[ianlee]

Min - All the major proposals to save the Eurozone represent back door attempts to pass the costs of saving the Euro i.e. saving southern Europe from its own bad behaviour, to Germany as they are the largest economy with the largest liability to the ECB, the EFSF etc.

Contra an emerging view articulated by Krugman et al, that Greece is a victim of Germany (due to imbalances which explains why they are deep in debt and thus not responsible), I found a graph from Eurostats that showed Greek debt to GDP was 22% in 1980 but had increased to just under 100% in 1993 - 7 years BEFORE they joined the Euro, while the Greek national railroad has annual labour costs 7x the annual income of the Greek national railroad and few people pay taxes.

From the German perspective, the GIPS countries are the authors of their own past bad decisions and they are now trying to pass the bill onto others. The Germans are simply saying nein to co-signing or paying off the problem child's bills.

What is fascinating is that in addition to the French (as their banks are owed a great deal by Greece), the other country most opposed to a Greek default was Greece as they understood it will be very difficult to borrow in future.

They support Eurobonds and annual transfers similar to Canadian equalization but are opposed to Brussels central control over their budget. Sounds like some of my students - "yes I failed the exam and yes my assignments were inadequate and late but I still want an A as all my friends got an A".

But it really does not matter. If a country wants to be sovereign, it must ensure it adopts policies that ensure its sovereignty and not like Blanche Dubois in A Streetcar named Desire, "depend on the kindness of strangers" (or Germans or Chinese).

[Mike Sproul]

Nick:

Nick:

I live in the US. If I want to borrow Chinese yuan, what's so stupid about that? Or carry it a little farther and suppose that I have circulated a lot of my IOU's around my town, which are denominated in US dollars. Now some of my assets are denominated in US dollars and some of my liabilities are denominated in yuan. Again, what's so stupid? Sure I'm taking a chance that the yuan might fall relative to the US dollar, but things could go the other way and I'd gain. Besides, the holders of my IOU's are better off if I hold a diverse portfolio of assets, rather than assets denominated only in dollars. And if people want me to act as a lender of last resort by issuing more of my IOU's to them, I'm not hampered by my yuan holdings. Especially if (like any central bank) I've suspended convertibility of my IOU's.

[Phil Koop]

First "bullshit" and now "stupid"; it appears that one of the most worthwhile of Canadian initiatives is to call names. Not that I disagree; on the contrary, I think you have understated your case. I would add:

1. What are the Europeans supposed to do with yuan once they have borrowed them? Use them to buy euros? Have they thought through the consequences of that?

2. Whence will come the yuan with which the loan will be repaid? Bought with euros? Will China like the consequences of that? Will Europe?

3. Isn't it absurd for China to be shipping money to the world's largest economy? Why should Europe be short of money, of all things?

[Min]

Ian Lee: " All the major proposals to save the Eurozone represent back door attempts to pass the costs of saving the Euro i.e. saving southern Europe from its own bad behaviour, to Germany as they are the largest economy with the largest liability to the ECB, the EFSF etc.

"Contra an emerging view articulated by Krugman et al, that Greece is a victim of Germany (due to imbalances which explains why they are deep in debt and thus not responsible), I found a graph from Eurostats that showed Greek debt to GDP was 22% in 1980 but had increased to just under 100% in 1993 - 7 years BEFORE they joined the Euro, while the Greek national railroad has annual labour costs 7x the annual income of the Greek national railroad and few people pay taxes."

So Germany knew the score before agreeing to let Greece join the Euro. ;)

The European situation has complexities that I do not pretend to understand. But I do know that in the good ole U. S. of A. California and New York (big, rich states) subsidize Mississippi and Louisiana (small, poor states). If you are going to have a monetary union with rich and poor members, you have to be prepared for that kind of thing. As Red Green says, we're all in this together.

[Min]

Phil Koop: "Why should Europe be short of money, of all things?"

Do you think that the fact that the shortage of money is not evenly distributed might have something to do with that?

[Lorenzo from Oz]

One thing that puzzles me about all this. Decolonisation involved literally scores of new countries issues new currency in replace of the imperial currency. (Not India, it was always on the rupee, but plenty of African countries, for example.) Leaving aside the debt problems, which are problems in themselves, why is leaving a currency zone and adopting a new currency regarded as so hard? It has been done lots of times. Including by countries such as Canada, Australia, (the US if you go far enough back) ...

I also ask the question here, if people don't want to go that far off topic.

[Min]

Lorenzo from Oz: "why is leaving a currency zone and adopting a new currency regarded as so hard? It has been done lots of times. Including by countries such as Canada, Australia, (the US if you go far enough back) ..."

The British gov't did not like it when their now U. S. colonies began coining and printing their own money (Colonial Scrip). It forbade its use as legal tender in, IIRC, 1754, and that was one of the grievances of the colonists. Later, during the war, the new Colonial Dollar did not do too well.

[ianlee]

So Germany knew the score before agreeing to let Greece join the Euro. ;)

"The European situation has complexities that I do not pretend to understand. But I do know that in the good ole U. S. of A. California and New York (big, rich states) subsidize Mississippi and Louisiana (small, poor states). If you are going to have a monetary union with rich and poor members, you have to be prepared for that kind of thing. As Red Green says, we're all in this together."

Min - yes the Germans and the other European countries did know generally that Greece did not meet Mastrict criteria in the 1990s, concerning indebtedness. But the European leaders of the day wanted to create the Euro as part of the greater "European project". Thus, they argued that the "economic divergences would converge over time" notwithstanding the economic disparities between north and south. Unfortunately, the economic divergences did not coverge but grew bigger in the following 10 years. Imports grew faster than exports as they were less competitive in the south.

And unfortunately, they did not create the United States of Europe with the Eurozone. Instead, they only created a currency union. But each country retained its own fiscal autonomy to do what it wanted including spending what it wanted and each country continued to regulate its own banks.

In other words, Europeans do not see that "they are in it all together", because they are not. While Americans see Californians or fellow Mississipians as fellow citizens and fellow Americans, the Germans do not see the Greeks or Spanish as fellow German citizens.

Imagine if Canada decided to give up the Canadian dollar and adopt the US dollar in a currency union and subsequently Canada developed large deficits due to lower productivity relative to the US. Do you think that Americans would want to bailout Canada or transfer large amounts of US tax dollars to help Canada with its deficit?

[Min]

Ianlee: "Imagine if Canada decided to give up the Canadian dollar and adopt the US dollar in a currency union and subsequently Canada developed large deficits due to lower productivity relative to the US. Do you think that Americans would want to bailout Canada or transfer large amounts of US tax dollars to help Canada with its deficit?"

Well, the Americans had a currency union without a sufficient political union during the Revolution. That did not work out too well, did it?

[Lorenzo from Oz]

Min: Later, during the war, the new Colonial Dollar did not do too well. But eventually the US got it right: more or less. Still, the world is full of countries who exited from imperial currency unions.

the Americans had a currency union without a sufficient political union during the Revolution. That did not work out too well, did it? ROFL: I wish I had said that. Wait! This is the internet, I can :)

[Nick Rowe]

Good comments. I'm grading midterms so can't really respond.

Phil Koop's comment is important.

I wish I knew more of the history that Lorenzo is talking about. Were the new currencies convertible into the old? Or both into gold?

[JP Koning]

I think you've missed the point. The last thing the Europeans want are yuan-denominated EFSF bonds - what would they do with the yuan?

The Chinese surely would not want yuan-denominated EFSF bonds - they need to invest foreign currency reserves, not yuan. Secondly, the Chinese are only gradually experimenting with building up foreign trading in yuan and yuan denominated assets. The don't want to start things off with a splash lest they lose control over the yuan market. Lastly, there is no infrastructure outside of China and Hong Kong for yuan clearing, so EFSF yuan bonds would be a non-starter.

I'd guess this is really just the Europeans flattering the Chinese in the media so that the Chinese will be more likely to buy Euro and US dollar denominated EFSF bonds.

[Bob Smith]

Dumb, yes, but does it surprise anyone?

It reminds me of Canada in the early 1990s when Ontario and other provinces started issuing US dollar denominated bonds as way of reducing their borrowing costs (albeit at the cost of shifting foreign exchange risk from their creditors to them) - the analogy's not a bad one, since much like the Euro countries, Ontario couldn't print its own currency (at least not while remaing part of Canada), but had a central banker who, in a pinch might be bullied into doing it for them. Hey desperate people who have to borrow will do so on any terms available (think degenerate gamblers and Tony Soprano).

On the other hand, it might not be that dumb an idea if it's some sort of currency/real economic hedging game. I mean, if the Chinese continue to keep value of the yuen low, then (setting aside the real operational issues associated with borrowing in yuen), then maybe there's isn't significant foreign currency risk (and you can borrow at a lower rate - win for borrowers). And if the value of the yuen rises vis-a-vis the Euro, well, that's a bummer for European borrowers, but on the other hand, it might be good for the European economy to the extent they can increase exports to China, so the cost of repaying the debt rises, but so does the Euro-zone's capacity to repay it. The same thing happened to Ontario in the 1990's. Given the sharp drop in the value of the C$, the cost of repaying $US denominated debt would have gone up. On the other hand, the drop in the value of the dollar also meant that Ontario became highly competitive vis-a-vis its largest market. Financing costs may have risen, but so did Ontario's ability to pay. Mind you, the Euro zone isn't Ontario (and the ability of some of less successful economies to export anything other than people is questionable), and China isn't the US (and probably doesn't account for 40 odd percent of the EU's economy), so if that's the game the EU is playing, I'm not sure that, factually, it's a good one.

[Jacques René Giguère]

Bob Smith :"On the other hand, it might not be that dumb an idea if it's some sort of currency/real economic hedging game."
When Québec nationalized the hydro companies, the banking syndicate refused to finace the deal. (At he times, essentiallly no Québec entities whether public or private could borrow from the big banks.)So the deal was financed in New York ( where nobody saw any problem in QC doing what ON had done long before...). SO Hydro-Québec began exporting to the U.S. as a hedge.
Meaning that insteas of ON having a secure supply , they had to develop nuclear. Ultimately. On is in fact exporting nuclear power to New England by way of Hydro-Québec.
Which , once againn demonstrates the link between capital and current account, one of the most misunderstood subjects among the policy makers...

[DD]

Commenter above mentioned the disunity of the eurozone. Well said. Unlike the united states, the european countries could care less apparently. If one decides to forgetadebt, tough luck.