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MONEY BACKSTAGE Mumbai, Monday, May 24, 2010 24
is that deeply troubled members of the
After months of Eurozone are trying to bail out each oth-
prevarication, panic is what er. The stronger countries’ balance
sheets are being contaminated by the
As Woody Allen once
observed: “More than any
drove the European Union to bailout process. It’s like sharing dirty
needles - we all end up HIV positive. other time in history,
assist Greece. Satyajit Das Do you see the PIIGS able to live with the mankind faces a crossroads.
stringent IMF criteria for bailout?
says the situation reminds One path leads to despair
Basically you can choose how you
and utter hopelessness. The
him of Mark Twain, who want to die. You can default and be os-
tracised from financial markets and re- other, to total extinction. Let
once said, “I wonder whether structure your economy. If Greece is un-
able to finance its debt or elects to de-
us pray we have the wisdom
the world is being run by fault and exit the euro, then Greece will to choose correctly.”
become isolated and enter a period of
smart people who are forced economic and financial decline.
putting us on, or by imbeciles The alternative is that you take the IMF
cure but the problems are probably in-
obligations in the future.
Given all this, what do you think is the fu-
who really mean it”. Das, an capable of solution and terminal. Tem-
porary emergency funding may help
ture of euro?
People are confusing the health of the
internationally renowned meet immediate liquidity needs but do Eurozone economies with the euro. The
not solve fundamental problems of ex- real problem is the Eurozone economies,
derivatives expert and the cessive debt and a weak economy. You particularly the weaker members who
author of Traders, Guns & must cut government expenditure and
raise taxes to reduce its stock of debt.
shouldn’t have been allowed to join the
monetary union in the first place. There
Money: Knowns and But the government is too large a part of
the economy and the suggested austeri-
is also a problem within the Eurozone
(similar to the China-US global imbal-
Unknowns in the Dazzling ty measures will put the economy into a ance) whereby Germany has financed
severe recession. In turn, this will drain European consumption to keep its ex-
World of Derivatives (2006, tax revenues making it difficult to re- port levels high. These problems need to
FT-Prentice Hall), spoke to duce the budget deficit. Most of these
has limited opportunity to grow or in-
be addressed, something which the cur-
rent plans neatly avoid addressing. The
Vivek Kaul last week. flate itself out of the problem. Without euro’s problem is slightly different.
the ability to devalue the currency, First, the effect of a Greek default via re-
Excerpts from the interview: Greece cannot address its fundamental denomination of its debt into new drach-
lack of competitiveness quickly. The ma (the Greece currency) would not af-
narrow economic base, primarily agri- fect the euro. Argentina and a whole host
How does a country as small as Greece

EU rescue is like sharing needles…

bring Europe to its knees?
Greece’s significance is not its eco-
nomic size. Greece has significant debts
(currently around €270 billion (113% of
GDP), which is projected to rise by 2014
to around €340 billion (150% of GDP)).
Much of this debt is owed to investors
outside Greece, mainly banks and in- of emerging market nations have de-


vestors in other European countries. As faulted on dollar debt with no impact on
of June 2009, Greece owed $276 billion to the currency itself. In fact, cutting out
international banks, of which around the unsustainable countries - those that
$254 billion was owed to European are unlikely to survive —- out of the
banks with French, Swiss and German euro in a form of battlefield triage would
banks having significant exposures. It is help the currency.
risk of default on this debt that has Germany has banned naked short-selling.
made it the centre of global concern. Amusingly all constitutional con- billion from the IMF). Then there is the Are we going to see more clampdowns
What happens in Greece is unlikely to cerns about the legality of a bailout €750 billion Eurozone stabilisation fund, from governments?
stay in Greece creating new problems were jettisoned with alarming speed. the Greek deal is ex-poste part of. The One couldn’t help but think of Mark Twain, The short-selling ban is a poorly con-
for the fragile global banking. Greece is The view was that it had all always been IMF would provide up to €250 billion of who had said, “I wonder whether the world is ceived and politically-driven initiative.
also the ‘canary in the coal mine’. It is possible under the “exceptional circum- the facility. The entire package requires First, it can’t possibly work as only Ger-
pointing to very similar problems in stances provision” (Article 122) to count- IMF participation, which limits the
being run by smart people who are putting us many has implemented it and other na-
other countries - the PIGS (Portugal, Ire- er a systemic threat. One couldn’t help amount of any bailout package and also on, or by imbeciles who really mean it”. tions are likely to be reluctant to follow.
land, Greece and Spain) as well as some but think of Mark Twain, who had said, makes it conditional on meeting the Secondly, blaming ‘wolfpacks’ — by the
eastern European countries. There are “I wonder whether the world is being fund’s stringent economic prescrip- way, wolves are seriously endangered in
also similar problems in the FIBS run by smart people who are putting us tions. The package requires countries to we have a solvency problem. Most of culture, tourism and construction, fur- Europe and are protected — misses the
(France, Italy, Britain and the US). on, or by imbeciles who really mean it”. exhaust commercial debt market these countries have unsustainable lev- ther limits options. point that through their trading actions,
The problem is a large amount of Do you think contagion was a given with- sources prior to accessing the package. els of debt. Beyond 2010, Greece needs to So essentially they have few options… they are pointing out the blindingly ob-
public debt, unsustainable budget out the nuclear option? The aid required “unanimous” agree- refinance borrowings of around 7%-12% The level of indebtedness may al- vious: that these states are effectively
deficits and unfavourable current ac- Contagion has already happened. ment among the EU members. of its gross domestic product (around €16 ready be too high. (Economists) Ken- bankrupt and not in a position to repay
count deficits both in absolute terms There are several channels of transmis- The European Central Bank (ECB) is billion to €28 billion) each year till 2014. neth Rogoff and Carmen Reinhart, in debt. They say about Shakespeare that
and relative to GDP. What Greece is sion. The first is other sovereigns. Oth- also providing support and has now re- There are significant maturing bor- their survey of financial crises called “they all quote him in the end”. When
highlighting is that such debt is unsus- er countries with similar economic laxed its rules completely and will ac- rowings in 2011 and 2012. In addition, This Time It’s Different, argue that once things go wrong in the financial mar-
tainable and investors will not continue problems will inevitably be scrutinised cept bonds as repo eligible irrespective Greece is currently running a budget the debt of a country goes above 60-90% kets, everybody looking for a scapegoat
to finance it, certainly not at current and targeted. Remember, when a sover- of rating. The ECB is also buying Euro- deficit of over 12% that must be financed of GDP, it acts to restrain growth. blames speculators and short-sellers.
rates and perhaps not at all. It is a prob- eign runs into funding problems, it zone sovereign bonds in the secondary using euros. Greece and some of the other countries’ Some statement about a worldwide con-
lem that was there all along. means that banks and other borrowers market. As of May 19, 2010, the ECB had Greece’s total borrowing, currently high levels of debt mean that interest spiracy, probably with a Jewish taint,
What got the EU to act after months of in that country are purchased bonds around €270 billion (113% of GDP), is payment now total around 5% of GDP can’t be far away.
In a single word, panic. The European
also affected. For ex-
ample, Greek banks q&a worth around €16.5 bil-
lion, mainly of the
forecast to increase to around €340 bil-
lion (over 150% of GDP) by 2014.
and are scheduled to rise over 8% by
GDP. Rising interest costs will only
Where do we go from here?
Frankly, things are fairly grim. The
Union spent months prevaricating were unable to fund
about any sort of assistance for Greece. themselves in the in- satyajit das porcine variety.
In addition, the
It is highly unlikely that Greece can
avoid a debt restructuring. For countries
worsen this problem. High levels of sov-
ereign debt are sustainable where three
world has too much debt. During the
first phase of the global financial crisis,
Then, Wham, bam, thank you M’am, ternational markets. ECB has been funding like Ireland, Spain and Portugal, as well conditions are met: First, the debt is de- governments and regulators did not
and they said, we have €110 billion for The second is the banking system. If banks such as those in Ireland and the others that will follow the same nominated in its own currency. It is want to acknowledge this and merely
Greece. And then when that did not Greece defaults or its debt falls sharply Greece.. Greek banks account for 6.6% route, the savage austerity measure re- helpful if the currency is also a major transferred the debt from private-sector
work they come up with a €750 billion in value then the losses affect the of all ECB credit to financials while quired are unlikely to be palatable and reserve currency, an advantage enjoyed balance sheets onto government bal-
package for all of Europe. lenders, wiping out capital. Given the holding only 1.6% of European Union probably won’t work in any case. by the US dollar. Secondly, there is a ance sheets. The debt never went away
EU leaders and worthies convinced fragile condition of major banks global- assets. Similarly, the Irish account for It is useful to remember that Argenti- large domestic saving pool to finance at all. Now, governments themselves are
themselves that the euro and therefore ly, this places pressure on their ability to 12% while holding 5.24% of assets. na had a debt to GDP of around 60% and the borrowing, such as exists in Japan. in trouble, some no longer able to fi-
the EU itself was under attack and at fund and lend, setting off a negative Also, because of the IMF involvement a budget deficit of 6%. They tried to make Finally, the country possesses a sound nance themselves. This means at best a
risk of collapse. So they went “nuclear” feedback loop that we saw in the early and direct bilateral facilities, it is a glob- the adjustments necessary to halve both and sustainable economic and industri- withdrawal of government support - or
to salvage the situation, and try to stop part of the global financial crisis. The al effort. The average American must be and didn’t succeed. After a long-drawn al base. These countries do not meet any lower spending and higher taxes —
contagion. third is the generalisation of credit a bit bemused to find that they are tip- struggle between 1999 and 2001, they were of the above criteria. which will reduce global demand and a
problems. We have already seen funding ping some $30+ billion into the hat to- forced to reschedule their debt and have There are no easy solutions… prolonged period of stagnation. At
costs rise across the board. Inter-bank wards the rescue via the IMF. The whole still not quite made their way back to nor- There are no more easy solutions. worst, we could see a string of sovereign
markets are become more expensive package is a mess. I think the EU and mality. Many countries we are talking Take Ireland, which has already debt rescheduling and a return to the
and losing liquidity creating liquidity ECB are hoping that the announcement about are in a much worse position. It’s implemented austerity measures. The worst days of the credit crisis. It’s now
It’s going to take a mira- shortages. will suffice to bring stability to markets going to take a miracle and those have al- government debt as a percentage of finely balanced. There is no political
cle and those have always Then these financial problems affect and they won’t ever have to use it. ways been in short supply. We have GDP has gone up to 64% from 43.9%. will to tackle the deep-seated problems.
been in short supply. The EU the real economy - growth, jobs, invest- Will the plan work? bought some time but markets present The budget deficit as a percentage of The electorate, which is poorly in-
rescue package has bought ment etc. In turn, this feeds back into At best, the plan can provide tempo- value outcomes and they have discount- GDP has doubled to 14.13% from 7.3%. formed, is unwilling to accept the ad-
the financial system and so on. The rary liquidity to cover immediate fi- ed the chances of a successful adjust- The nominal GDP of the country has justment and lower living standards
some time but markets pres- process is difficult to control or manage. nancing needs. For example, the event ment. I think they are correct. fallen by 18%. Given many of these that will be necessary. As Woody Allen
ent value-outcomes and they Can you explain how exactly is the plan that crystallised Greece’s problem was How will EU finance the rescue effort countries have low growth, high unem- once observed: “More than any other
have discounted the chances supposed to work? its need to repay maturing debt and also given that its member-states are heavily ployment (Spain’s unemployment rate time in history, mankind faces a cross-
The fine points of the plan are still issue bonds to finance its deficit. (Ger- indebted? is 20%), the likely social and political roads. One path leads to despair and ut-
of a successful adjustment. I sketchy. As I understand, Greece gets man chancellor) Angela Merkel had ad- That’s the really funny part. We are consequences are extremely severe. I ter hopelessness. The other, to total ex-
think they are correct. €110 billion in emergency loans (€80 bil- mitted as much. trying to solve a problem of too much am not sure that the cure is feasible or tinction. Let us pray we have the wis-
lion from Eurozone countries and €30 But we don’t have a liquidity problem; debt with more debt. What is also bizarre will help make it easier to meet the debt dom to choose correctly.”


Setting a progressive agenda that rivals the New Deal, no less

With the US Senate’s passage of finan- Federal Reserve, which did not distin-
cial regulation, Congress and the White guish itself during the housing bubble. Momentous moves Reagan thrust in some important ways.
Although the Reagan administration did
changes. This would hurt financial
firms’ ability to act as a middleman,
House have completed 16 months of ac- Already, though, one downside to the First came a stimulus bill that, while not shrink the size of the federal gov- much as Expedia and other travel Web
tivity that rival any other since the New legislative spurt does seem clear. By fo- aimed mainly at ending a deep reces- ernment, it changed the ways that Wash- sites have hurt travel agents.
Deal in scope or ambition. Like the Rea- cusing on long-term problems, Obama sion, also set out to remake the ington collected and spent its money, by For all these differences, though,
gan Revolution or Lyndon Johnson’s and the Democrats have given less than nation’s educational system and vastly reducing taxes on the affluent, cutting there are also ways that Obama and to-
Great Society, the new progressive peri- their full attention to the economy’s cur- expand scientific research some social programs and increasing day’s Democrats have accepted, and are
od has the makings of a generational rent weakness and turned off a good Then President Barack Obama signed military spending. even furthering, the Reagan project.
shift in how Washington operates. number of voters. a healthcare bill that was the biggest These policies ended up magnifying in- They are not trying to raise tax rates on
First came a stimulus bill that, while After months of discussion, and with expansion of the safety net in 40 years come inequality, which was already ris- the affluent to anywhere near their pre-
aimed mainly at ending the unemployment And now Congress is in the final ing for other reasons. Since 1980, median 1981 levels. Their health bill tried creat-
a deep recession, also rate hovering near a stages of a bill that would tighten Wall household income has risen only 30 per- ed new private insurance markets, not
set out to remake the na- 27-year high, Democra- Street’s rules and probably shrink its cent, adjusted for inflation, while average expand Medicare.
tion’s educational sys- tic leaders said Thurs- profit margins incomes at the top have tripled or quadru- Most striking, the administration is
tem and vastly expand day they had finally pled. Every major piece of the Obama trying to improve public education by in-
scientific research. reached agreement on agenda is meant, in part, to push back troducing more market competition.
Then President Barack comment a bill that would send I’d have told you it was going to fizzle achievements. And given the difficulty against inequality. Government may Even with those bubbles, the nation’s
Obama signed a health- David Leonhardt aid to states and take into virtually nothing,” said Theda of getting anything done under the grid- grow, but the bigger change will be how economic output expanded only 20%
care bill that was the other steps to increase Skocpol, the Harvard political scientist. lock of Congress, it’s pretty surprising.” the government is spending its money. from 2000 through 2009. In the 1980s, it
biggest expansion of the safety net in 40 job growth. Congress plans to vote on the “Now it could easily be one of the pivotal The last 16 months seem most similar The health bill expanded insurance grew 35%, and in the 1990s, it grew 37%.
years. And now Congress is in the final bill next week. But some of the money periods in domestic policy.” But, Skocpol in scope to three other periods in the last coverage largely for middle-class and Will this new progressive project suc-
stages of a bill that would tighten Wall will not be spent for months and may not added, “It will depend on what happens 80 years. After World War II, the federal poor families and paid some of the bill ceed? There are any number of uncer-
Street’s rules and probably shrink its be enough to affect voters’ attitudes be- in the next two elections.” government helped build the modern by taxing households making more than tainties: whether enough charter schools
profit margins. fore November’s midterm elections. The recent period surely will not middle class with the GI Bill, housing $250,000 a year. Attached to the final will succeed, whether the new health in-
If there is a theme to all this, it has Still, the turnabout since January 20 match the impact of the New Deal. Noth- subsidies, the highway system and in- health bill were also education provi- surance markets will function well,
been to try to lift economic growth while — the first anniversary of Obama’s in- ing is likely to, notes David Kennedy, a centives for employers to offer health in- sions that cut subsidies to banks making whether the Fed will learn to become an
also reducing income inequality. Growth auguration and the day after Scott Pulitzer Prize-winning historian, be- surance. The 1960s — mostly under John- student loans, and used much of the effective regulator of Wall Street.
in the decade that just ended was the Brown, a Republican, won a Senate seat cause the New Deal created much of the son, but also Richard Nixon — brought money for college financial aid instead. Some of those questions won’t be re-
slowest in the post-World War II era, in liberal Massachusetts — has been re- modern American government. “These civil rights legislation, Medicare, Medic- The financial regulation bill, mean- solved for years. But one issue should
while inequality has been rising for markable. Then, commentators pro- are not as dramatic as the foundational aid and environmental laws. Then Rea- while, would take several steps likely to become clear much sooner. Reagan,
most of the last 35 years. nounced the Obama presidency nearly moments,” Kennedy said, “but they’re gan ushered in a period that continued, reduce Wall Street’s profits —- and Wall Johnson and Franklin D Roosevelt ce-
It is far too early to know if these efforts dead. Today, he looks more like a liberal significant changes.” more or less, until 2008: tax cuts, less reg- Street has created more multimillion- mented their changes by retaining
will work. Their success depends enor- answer to Ronald Reagan. Alan Brinkley, a historian of the De- ulation and other attempts to unleash the aires in recent decades than any other enough allies in Congress and serving
mously on execution and, in the case of fi- “If you’d asked me about this admin- pression, added: “This is not the New competitive forces of the market. industry. To take one example, certain more than four years in the White
nancial regulation, specifically on the istration after Scott Brown was elected, Deal, but it’s a significant series of Obama has been trying to reverse the trades would be forced onto open ex- House. Obama has yet to do so. NYT

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