True Finns continue to rise

Last week, the True Finns announced that it could not participate in a Coalition government that supported the bail-out of Portugal, its opposition to which was a key plank of the party's election manifesto. Announcing the decision, True Finns leader Timo Soini said, "It would have been nice to be part of the government but you cannot betray yourself."

Soini may have passed up on power, but his decision seems to have gone down well with voters. In an opinion poll carried out at the end of last week - when it had already become clear that the True Finns would not join the government due to the Portugal bail-out - the party got 22.4%, beating its election score by over 2% and making it the biggest party for the first time. It is trailed by the National Coalition Party on 20.6%, the Social Democrats on 18.6% and the Centre Party on 14.4%.

At this rate - particularly if the eurozone continues to deteriorate, requiring more bail-outs - Soini could become absolutely lethal in four years' time. It's that tension again, inherent in the eurozone structure - political ambition vs national democracy vs. economics...

On a separate note - irrespective of what we think of the True Finns - there's an interesting contrast here to a certain UK party, which, upon joining a Coalition government as a junior partner dropped from 23% at the election to 18% just over a month later and falling even lower this year.

Signals Spain May Seek Bailout Spelling Disaster for Eurozone
The shadows of people taking part in a demonstration organised by the group dubbed 'Youth Without a Future' in Madrid, to protest against professional and social conditions of the youth in Spain, May 15, 2011

Greece Denies Eurozone Exit Plan
George Papandreou, the Greek prime minister, is denying his country is getting ready to leave the Eurozone.

Rumours that Athens was quitting the single currency has lead to a fall in the value of the Euro.

Finance Ministers from the Eurozone's biggest economies have been holding talks on Greece's debt crisis.

Greece's sovereign debt stands at $470bn. That is more than a year-and-a-half of its entire economic output.

The European Union and the International Monetary Fund agreed a loan of $160bn in May last year. The terms were eased in the spring.

But the financial markets consider the high repayments as unsustainable, leading to growing fears of a default. That could spell disaster for the Eurozone.

Al Jazeera's Tim Friend has more.

Geheimtreffen der EU-Finanzminister: Euro-Kernländer schließen Umschuldung Griechenlands aus
FRANKFURTER ALLGEMEINE: Nach dem unangekündigten Krisengipfel der EU-Finanzminister erklärte der Chef der Eurogruppe, Luxemburgs Finanzminister Juncker, eine Umschuldung Griechenlands komme nicht in Frage. Einen Austritt Griechenlands aus der Euro-Zone bezeichnete Juncker als „dumme Idee“.

Die Kernländer der Eurozone haben bei einem unangekündigten Treffen in Luxemburg in der Nacht zum Samstag den Ausstieg Griechenlands aus der Währungsunion ausgeschlossen. Der Chef der Eurogruppe, Luxemburgs Finanzminister Jean-Claude Juncker, sagte nach dem Treffen, auch eine Umschuldung Griechenlands komme nicht in Frage. Einen Austritt Griechenlands aus der Euro-Zone bezeichnete Juncker als „dumme Idee“. Das wäre „ein Weg, den wir niemals gehen würden“, sagte er. „Wir wollen nicht, dass der Euro-Raum ohne Grund explodiert“, fügte er hinzu.

An dem Treffen in einem Schloss bei Luxemburg nahmen unter anderen die Finanzminister aus Deutschland, Frankreich, Italien und Spanien teil. Weitere Teilnehmer waren der Präsident der Europäischen Zentralbank (EZB), Jean-Claude Trichet, EU-Währungskommissar Olli Rehn und der griechische Finanzminister Giorgos Papakonstantinou. » | FAZ.NET | Samstag, 07. Mai 2011

From tomato sauce with pasta to Honorary German

Bild, Germany’s largest newspaper, yesterday came out in support of Mario Draghi’s candidacy for the role of ECB President, proclaiming him to be a “Honorary German Citizen”.

Clearly they don’t do things by halves…

In February Bild screamed "Mamma Mia!" over the thought of an Italian running the German currency. They claimed: “For Italians, inflation is a way of life, like tomato sauce with pasta.”

We’d expect that it won’t be too long until Merkel publicly comes out in support of Draghi (given that neither Sarkozy nor Bild would have supported him without her private approval).

To be honest, he’s been the only real candidate for a while – in terms of both skills and personality – but the fact that it took so long for an established professional, and the right man for the job, to overcome the massive stereotypes in Europe might say something about so-called EU unity… the picture doesn’t help either.

The Great Euro Gamble

In today's Wall Street Journal we argue,

"When European Union leaders forged their monetary union without a full political and economic merger, they gambled on two vital factors: That economic forces could be kept in check, and that national democracies could be managed.

Over the past 16 months, we have been reminded time and again exactly how big and how irresponsible those gambles were. Sunday's was arguably the strongest reminder yet, courtesy of the anti-euro True Finns party that may hold the balance of power in the next Finnish government. Paris, Berlin and Brussels seem not to have factored Nordic populism into their grand plans for the euro. But ultimately the euro zone is about politics, and politics remain as local as they ever were."

We go on,

"The True Finns' success will not change European politics overnight, and the party may not even succeed in blocking Finland's participation in future bailouts. But, irrespective of what we think of the True Finns, the election does highlight how powerfully a euro-zone crisis can contribute to shaping national politics. Euro bailouts were also an important issue in Slovakia's elections last year, and helped to deliver a new governing coalition that refused to take part in Europe's Greek bailout. That government only reluctantly kicked in later to help create the temporary bailout fund that euro leaders are now looking to replace after 2013.

This year the True Finns asked voters to consider the same question that Slovaks did last year: Why should they work harder and retire later to pay for the mistakes and wasteful habits of southern European governments? This "triple-A populism" has proven a powerful force in a number of countries with sparkling credit ratings, including Germany. Writ large, this weekend's Finnish elections are a rebuke of one of the euro zone's central, and fatal, conceits: that political ambition can trump economic and democratic realities."

Looking at EU leaders' gamble on being able to keep economic forces in check, we note,

"Markets have now finally woken up to the fact that Greece and Germany are poles apart; it is time for EU leaders to do so as well. Ireland, Greece and Portugal have made all too clear that economic forces can rarely be predicted, let alone contained.

Some particularly federal-minded EU leaders took this as a pretext to push even harder for a full-fledged fiscal union. Former European Commission President Romano Prodi wrote in an op-ed in the Financial Times last May that "When the euro was born everyone knew that sooner or later a crisis would occur. . . . I was warning years ago that, through no one's fault in particular, extraordinary events could occur that would force joint co-ordination of fiscal policies."

That sentiment spurred EU leaders to take their next major gamble, which was even riskier than the first: They bet that once they did start to effect robust economic and political union, national voters and parliaments would play along and vote the "right" way. So last year, when the EU elites decided to break their own treaties and turn the euro zone into a de facto debt union, they forced taxpayers in some countries to take on the liabilities of foreign governments in other countries—without the possibility of voting these governments out of office. But taxpayers are now showing signs of revolt. "

We conclude,

"Will EU politicians' second gamble turn out as ill-judged as their first? Time will tell. But one thing is clear. The political price that European leaders are paying to keep their flawed project afloat continues to rise."

Furious Greeks Press for Country to Default on Debt
THE OBSERVER: Violence on the streets as backlash grows over Greece's austerity package and €110bn bailout

A growing chorus of voices is urging the Greek government to restructure its debt as fears grow that a €110bn bailout has failed to rescue the country from the financial abyss and is forcing ordinary people into an era of futile austerity.

"It's better to have a restructuring now … since the situation is going nowhere," said Vasso Papandreou, whose views might be easier to discount were she not head of the Greek parliament's economic affairs committee.

Other members of prime minister George Papandreou's party have said that Greece is locked in a "vicious cycle", unable to dig itself out of crisis with policies that can only deepen recession.

International fears of a Greek default rose last week after the German finance minister, Wolfgang Schäuble, refused to rule it out and markets, sensing upheaval, sent Greek borrowing costs soaring.

The normally mild-mannered prime minister has vehemently rebuffed the prospect of Greece failing to meet its debt obligations, saying restructure would not only be catastrophic for the country – blocking its access to markets for years – but also for the eurozone's delicate economy. "Our problems will be addressed in depth not if we restructure our debt but if we restructure the country," he said, announcing the "road map" that would lead Greece out of crisis.

Amid speculation over the country's ability to avoid default, a wave of civil disobedience is causing many to wonder if Greece is becoming ungovernable. Read on and comment » | Helena Smith in Athens | Sunday, April 17, 2011

First to the Finnish line

This is a graph showing the support for the different parties, according to a poll published last night, ahead of the Finnish national elections on Sunday. All international eyes are on the True Finns (fourth from the left) - the party that has said it opposes a bail-out deal for Portugal and putting any more cash on the table for struggling eurozone economies. In fact, the party doesn't want to be in the euro at all.

A lot has been said about the True Finns, with the European media all of a sudden forced to become experts on Finnish national politics - it has to be said with varying degrees of success. That many still refer to the True Finns as a "right wing" party indicates the need for a bit more analysis and a bit less reliance on labels that are flying around. The party is pretty skilfully moving along the right-left scale. It's effectively social democratic on economic and welfare issues, favouring a big state, combined with a pretty clear socially conservative flavour. It's definitely populist and not exactly enthusiastic about immigration (and this in a country which accepts some of the fewest migrants in Europe).

So what will happen on Sunday? We wouldn't bet our money on any player. The True Finns have seen a drop in support recently - 15.4% in the poll published yesterday, down from 17.2% a month ago. The National Coalition Party extended its lead to 21.2% in yesterday's poll, while the Centre Party was the second largest party at 18.6%. The Social Democrats were at 18%. The Nordic bookies don't think the True Finns will make it into government and will give you 2.10 times your money for a bet on them winning ministerial seats, while a bet on them not making it only gives you 1.65 times your money.

Regardless, the True Finns are likely to make huge gains compared to the last elections in which they scored just over 4% (see the rise of the True Finns here, in yellow). And a second thing to remember, the Social Democrats - currently at 18% - have also expressed pretty clear opposition to a Portuguese bail-out, instead arguing for a restructuring. Between them, the two parties could well reach above 30% - that's a pretty powerful anti-bail-out bloc. As we've noted before, this could potentially hugely complicate a Portuguese bail-out, as well as efforts to top up the temporary bail-out fund (EFSM) and cash injections in to the permanent rescue mechanism (EFM).

The elections in Finland have made people - not least many opinion formers - start to realise that, shock horror, ultimately the eurozone is about politics. And as we know all politics is local.

In fact, it's difficult to find a more conspicuous example of the inherent flaws of the eurozone - the idea that political ambition can stamp out both economic and democratic realities - coming up against the full force of national democracy.

Why is Portugal in trouble?

Solving the problem should undoubtedly be the priority now, but looking at how Portugal got into this mess might help to formulate a solution.

Clearly there were many factors which helped to precipitate the current crisis, including numerous domestic political and policy mistakes. However, being a member of the single currency definitely seems to have played a part.

According to an interesting paper published by European Commission officials, joining the euro had the following consequences:

"The Portuguese economy went from a boom led by in the second half of the nineties to a marked slowdown in this decade (Chart 1). A major impulse for the expansion was the considerable fall in interest rates when the prospect of accession to EMU became increasingly self-validating. Nominal short-term interest rates fully converged to those at the common low level set by the ECB (Chart 2)."

The paper suggests that the "substantial fall in interest rates, [was] the main trigger for the boom", which later resulted in a bust. The interesting difference with Portugal, compared to Spain, Ireland and Greece, is that it experienced the infamous boom - bust dynamics before it entered the eurozone, but still because of the "prospect of accession to EMU", as the officials put it.

The eurozone's "sleeping pill" dynamics (as Herman Van Rompuy puts it) have prevented investors from forcing the country into unpopular, but necessary, reforms to boost competitiveness, resulting in Portugal becoming 21% less competitive relative to Germany over the past decade (this looks to be true of the past and current crisis).

So when Portugal experienced its bust, long before Spain and Ireland experienced theirs, there wasn't a currency which could come under strain and thereby discipline the politicians. This was surely one of the reasons for the consistently sluggish growth in Portugal following its bust.

There is, obviously, more to it though. Thanks to the ECB's artificially low interest rates, which were designed for a slow growing Germany, the country started accumulating very high levels of private debt, up to more than 200 percent of GDP (just like in Spain and Ireland, however, they managed to grow at the same time ).

On top of all of this, the Portuguese government hasn't exactly been a shining example of sound budgetary management. It has run large budget deficits for many years and has accumulated a significant level of debt for an economy the size of Portugal's (both the debt and deficit figures for last year were recently revised upwards as well).

Fundamentally however, an overvalued currency which prevented growth (the Escudo would have decreased in value following the original bust), combined with interest rates which were an ongoing stimulus to take on new debt, left Portugal with a decade of low growth. The resulting fall in relative living standards, compared to the rest of the EU, and the fall in tax receipts further fuelled the build up of both private and pubic debt.

Interestingly, Portugal's problems can provide some hint at what the future may hold for Greece, Ireland and possibly Spain. Even loose monetary policy and boosts in liquidity (admittedly in debt form) didn't solve Portugal's underlying competitiveness and currency problems, in fact they may have made things worse.

These lessons from Portugal's past should be heeded by those in charge. Tackling the root causes of this crisis - eurozone imbalances, competitiveness problems and the banking crisis - is of paramount importance, as is providing for all eventualities, including a restructuring and possibly even a change in eurozone membership.

When those who claim to know get it wrong

Last June, we published a pamphlet titled "They Said It: how the EU elite got it wrong on the euro", in which we compared what politicians, central bankers, journalists and opinion makers said about the Single Currency before the eurozone crisis erupted - to what they say now. It's a pretty shocking read, and should make people think twice before making the argument against EU-related referenda on the grounds that 'average people are too stupid to understand such complex issues'. On the euro, by far the most important issue relating to the European project, it was the elite (in politics, in media and elsewhere) who got it spectacularly wrong - for whatever reason: political vanity, ideology, short-term thinking, ignorance or plain incompetence.

Take the FT's Wolfgang Munchau, for example. For years, the guy churned out columns praising the euro, sometimes with caveats, but nothing like the stuff we're seeing now.

Back in 2006, Munchau argued:

"There is not the slightest danger of a break-up of the Eurozone. On the contrary, I expect the Eurozone to be exceptionally stable in the long run. Make no mistake, the Eurozone is here to stay".

And in 2008,

"The world's two large reserve currencies, the dollar and the euro, offer more protection from speculative attack than a free-floating offshore currency unit. The UK will at some point have to make a choice whether it wants to be in the Eurozone or whether it wants to seek an alternative use for those rather tall buildings in the heart of London".

We're not saying that he's not making many valid and interesting points in his columns. But seriously, these are painfully inaccurate predictions. And compare to what he's been saying over the last few months:

“The probability of scenario four [eurozone break-up] cannot be zero or even close to zero. When the eurozone crisis broke out, the probability of failure was considered as small, but non-trivially positive. It is higher now despite the ‘whatever it takes’ pledge…My point is that if Germany is serious about limited liability – and I believe it is – the probability of a break-up is anything but tiny.”

Trust us, we can make the list of contradictory quotes from Munchau very very long. In fact, we could write a new "They said it" every single month, and wouldn't have any difficulty filling it with material, as established figures continue to contradict themselves on the euro.

Take this from the BBC's economics editor Robert Peston - who clearly is a clever and nice chap - but on potential UK liabilities in a Portugal bail-out he was just plain wrong, as we noted at the time. Two weeks ago - when it was becoming obvious that Portugal would had to seek a bail-out -he noted on his blog and on the Today Programme (and contrary to what we said):

“Only in the event that the Portuguese financial crisis exhausted the available money in the eurozone's bail out fund - which it won't - would the UK become liable.”

Last week, when the Treasury had confirmed that the UK will be partly liable, Peston did a U-turn:

“First of all, it does now look as though the implied UK contribution to the Portuguese bailout will be around 4.8bn euros or £4.2bn (in line with what I've been saying).”

Excuse us?

Okay, so the eurozone crisis is a moving target and we all get stuff wrong from time to time, but this is pretty bad. It's also interesting that those complaining about the poor coverage of EU issues in UK media never quite seem to look at the flip side of the coin.

Another one bites the dust…

Portugal’s announcement that it too will tap the EU/IMF bail-out fund comes as no surprise. As we’ve argued many times before, it was merely a question of time. The announcement has however send eurozone hawks into a tailspin as questions over the amount, timing and conditions remain to be answered. Here’s some leaks picked up from the Portuguese press and elsewhere.

The size of the bail-out is expected to fall between €70bn to €90bn. Jornal de Negócios today reports that Jean-Claude Juncker says €75bn could be “appropriate”. Similar figures have been flying around for some time though. The Portuguese papers are somewhat less conservative, with many papers citing Diário Económico's estimate that the figure could rise to €90bn.

Público report that Guy Schuller, a Spokesperson for Jean-Claude Juncker says that technically there is no reason why some of the bail-out cannot arrive before the elections. This is also backed up by a European source close to tomorrow’s ECOFIN meeting who is cited in Dow Jones saying, “It will be difficult to concede a total package to a caretaker government” but “part of the resources could arrive before the elections”. “The preliminary technical work for the case of Portugal has already been done”, making it possible to issue the resources with “great speed”, claims the source.

The bail-out news has received a mixed response within Portugal, President Anibal Cavaco welcomed the move, announcing his support for caretaker PM José Sócrates and calling for “an attitude of responsible cooperation from the opposition parties”.

Opposition leader Pedro Passos said he supports the move, claiming it’s a way “to guarantee the national security and to preserve the reputation of Portugal abroad”. However, Reuters quotes a senior EU official who said that “the conditions demanded by Brussels are going to be very similar to the measures of the PEC, rejected in March by Parliament”. The same conditions which Passos so vehemently opposed just two weeks ago.

A Portuguese government source confirmed today that a bail-out will only be arranged with the support of the opposition. The National Federation of Trade Unions for the public sector will hold a strike on 6 May under the guise of getting “the IMF out of Portugal”, reports Diário Económico.

Meanwhile, the President of the Portuguese Banking Association has said that the ECB gave “clear instructions” to the banks to reduce their exposure to the government and other public sector bodies.

Some straight talking from Borg

Anders Borg, the Finance Minister of non-euro member Sweden, today had some strong things to say about how the Portuguese government has handled itself. He told Swedish Radio:

"We have reason to be very critical of the Portuguese government. This is a decision that should have been made in November, December. It’s been obvious for a long time that this country can’t stand on its own two feet.

There have been very frank discussions but the discussions have got stuck in internal political discussions instead of the necessary decisions are being made.

The Portuguese government has made the situation worse for itself and has contributed to an uncertain situation which has cost jobs and wealth in other countries. So we have reason to be strongly critical of them."

On the question on whether Sweden will contribute to a bail-out,

“It’s so complicated so we need to wait until some pieces fall into place.”

Pretty tough talk.

Portugal: so what are the options?

Despite Portugal asking for a bailout there is still massive uncertainty over what form a bailout would take and how large it would need to be. Below we have broken down the potential size of the bailouts and what funding needs they could cover in Portugal. We have also looked at what amount the UK would be liable for in each (as outlined in our briefing on the Portugal bail-out published the other week):

Total cost of a Portuguese bail-out: €60bn
Debt maturing this year = €12.3bn (Short and Long term from June onwards)
Debt maturing in 2012 and 2013 = €17.25bn (Long term only)
Deficit for the next three years = €28.3bn (2011 - 2013)
(This leaves €2.15bn leftover, which could be used to aid the banking sector, or simply to allow some room for manoeuvre within the bail-out)

This is likely the lowest viable level for a bail-out package since it only just manages to cover Portugal up to the end of 2013. Any lower and the money would not be sufficient to cover Portugal’s costs for a reasonable amount of time.

Total cost of a Portuguese bail-out: €70bn
Debt maturing this year = €16.8bn (Short and Long term from April onwards)
Debt maturing in the next three years = €23.8bn (Long term only)
Deficit for the next three years = €24.74bn (Apr 2011 – mid 2014)
Banking sector aid = €5bn

At this level Portugal could be taken off the markets from now until mid 2014, we expect a full bailout of Portugal to be of this magnitude (possibly up to €75bn)

Total amount of a Portuguese bail-out: €80bn
Debt maturing this year = €16.8bn (Short and Long term from April onwards)
Debt maturing up to the end of 2014= €30.4bn (Long term only)
Deficit for the next three years = €27.1bn (Apr 2011 – end 2014)
Banking Sector Aid = €5.7bn

An €80bn bail-out package could take Portugal off the market until the end of 2014. This includes covering the debt as well as the deficit from now until the end of 2014. There would also be scope to provide the banking sector with €5.7bn to aid recapitalisation or to encourage lending to households and SMEs. This will be a harder sell to some of the Triple A rated countries, especially if they believe Portugal could make do with less.

Total amount of a Portuguese bail-out: €90bn
Debt maturing this year = €16.8bn (Short and Long term from April onwards)
Debt maturing up to the end of 2014= €30.4bn (Long term only)
Deficit for the next three years = €27.1bn (Apr 2011 – end 2014)
Banking Sector Aid = €15.7bn

The extra funding here could be put towards covering or reducing some of the short term debt which may still be required for unforeseen funding costs over the three years. This amount could be floated as a way to make sure there are no renegotiations or shortage of funding as seen in Greece and Ireland.

Obviously, the amount that the UK would be liable for increases with the level of the bail-outs, however, there is still a very large range given the various structures which the bail-out could take:


It is important to note that any bail-out would not impose direct costs onto the UK, other than the cash contributions which the UK makes to the IMF. However, a bailout is still significant for UK taxpayers, as it effectively requires them to underwrite the debt of peripheral eurozone economies. The liabilities also significantly increase the level of UK exposure to these economies. In any case, if a firm took on large liabilities they would need to be declared in its accounting procedures and would be taken account of by anyone who assessed the financial state of the company. The same should definitely be true of governments.

There has also been talk of bridge loans, see our previous post for a discussion of that issue.

What's the truth about the True Finns?

We have received a couple of comments in regards to our blog post below on the rise of populist parties in the wake of the eurozone bail-outs. Some have been unhappy about our assertion that the Front National is gaining ground in French politics, whereas others have taken issue with us mentioning the True Finns in the same breath as the Front National and FPÖ (the expression "not as bad as FPÖ" has caused particular offence).

But on the point about the True Finns, a clarification might be appropriate. The True Finns party, or Perussuomalaiset in Finnish, has its roots in an anti-incumbency, rural protest movement from the 1950s, leading to the formation of a political party, eventually named the Finnish Rural Party. The party's dissolution in 1995 led to the creation of the True Finns (one of the party's slogans, "Crush the power hold of the old parties", is testament to its heritage). More than anything else, its euroscepticism seems to flow out of this tradition (which also explains its opposition to providing more cash to the temporary eurozone bail-out fund, the EFSF, for more bail-outs - bail-outs which we agree aren't really working).

So clearly, the party has very different roots compared to other Scandinavian populist parties, such as the Sweden Democrats and the Danish People's Party (for Swedish speakers, here's an article breaking it down). The Front National, Geert Wilder's Freedom Party etc are much farther away again from the True Finns.

In other words, the party cannot be described as "far right", as some non-Finnish media insist on so doing. However, it cannot be described as "centre-right" either, as it draws heavily from an old school, social democratic agenda (i.e. high taxes and a big welfare state). Kind of like a social democratic tea party, with a lot of emphasis on national sovereignty and independence.

According to an opinion poll published today, the party has lost some ground over the last few days, and are now fourth in the race (compared to second in a poll published the other week) - a race that is still wide open it has to be said.

What makes this interesting for the EU and the eurozone is that Finland is the first Triple A eurozone country in which euro bail-outs have become a national election issue. As the leader of the True Finns, Timo Soini, put it, the election might evolve into the referendum which the Finnish people were refused when the euro was first introduced.

We shall see.

A fight breaks out in a bar...

Last week we organised a debate in London on the EU's proposed short-selling rules (a summary of the event can be found here). With four excellent panellists, we covered lots of ground and managed to get into the crucial details without losing track of the bigger picture (always a challenge with what is, after all, a highly technical piece of financial legislation).

The proposal is currently gridlocked in negotiations between MEPs, member states and the Commission.

As it stands, the proposed short-selling regulation is a mixed bag - some much needed transparency measures are welcome, but some provisions on the table could be counterproductive and hurt weaker European economies . In particular, MEPs want to impose a blanket ban on short-selling of "uncovered" Credit Default Swaps on sovereign debt, to counter "speculation" against weaker eurozone economies. That the Commission, and virtually everyone else, has pointed out that there is no evidence that short-selling drives up borrowing costs for governments, seems not to matter.

MEPs insistence on a blanket ban is all about political games - it has nothing to do with economic realities. As MEP Syed Kamall (who's opposing the ban) noted at the debate - and others have noted as well - when a fight breaks out in a bar, you don't hit the guy that started the fight, you hit the one you always wanted to hit (see picture - we'd like to say that the two guys sitting down chilling are representative of the UK's approach to Europe but that might be a bit harsh, at least in this case).

We take a closer look at the proposal and state of the negotiations over on Public Service Europe. We acknowledge that,

The overarching goals of the European Union's new short-selling regulations are supposed to "create a harmonised framework for coordinated action at European level, increase transparency and reduce risks". These are commendable aims, which are also widely accepted by those within the industry.

But on the proposed CDS ban, we note

In fact, in many cases, the ability to "go short" increases investments in struggling economies since it serves to reduce risks involved in that investment – while offsetting the exposure investors may have to long positions elsewhere. Take away this form of insurance, and fund managers will grow increasingly reluctant to invest in the very economies that are in need of cash inflows.

For example, take an investor who considers putting his money into a project or enterprise in one of the eurozone economies, which is struggling to cope with large levels of debt at the moment. Naturally, he will want to have a way to hedge or insure himself against potential losses, in what is a risky economic environment. One way of doing this is to take a short position on the sovereign debt of this country in order to offset some of the risk. An excessive ban on CDS short-selling activities would reduce the flexibility of markets to respond to these kinds of risks, which in turn increases the cost of capital and reduces investments in - and lending to - struggling eurozone economies.

Alluding to the "fight in a bar" analogy, we conclude,

The biggest problem with this proposal is, therefore, that it is driven by a narrow political agenda rather than economic evidence, best practice and common sense. It is easier for politicians to accuse "speculators" - a vague group of people that is never really defined - for carrying out an evil conspiracy, than to deal with the real problems facing the EU economy. Such as low growth, an undercapitalised banking sector, an unsustainable single currency and governments spending money they do not have.

Unfortunately, in this fight it seems as if, rather than improving financial regulation, struggling European countries will be hit the hardest

Downing Street goes for much needed shock therapy

With the eurozone destined for years of navel-gazing, as it struggles through the current sovereign debt and banking crisis, the UK is actually very well placed to push for EU reform. Its own economic challenges aside, Britain now has a chance to use the debt and competitiveness predicament facing several European countries and the EU as a whole as a springboard to get Europe back on the road to growth.

In other words, this could be turned into a benign crisis for those of us who are in favour of a growing and competitive Europe (it's hard to argue that Europe doesn't need reform when several countries are on the verge of bankruptcy).

Encouragingly, Downing Street has moved today to try and push this agenda, with a new initiative entitled "Let's choose growth" - and there's lots of good stuff in there (and the format is refreshingly innovative and easy to grasp, including this You Tube clip). Besides the proposals to liberalise the single market further, by creating a common market for digital and service industries and calling for deregulation, there also seems to be an emphasis on 'shock therapy'. Cameron and Co have made it plain to EU leaders that standing still is not an option as the rest of the world moves on.


This chart should be all the motivation Europe needs. As you can see, by 2050, only Germany and the UK are predicted to remain among the world's economic elite, and they will only be hanging on to the bottom two rungs of the ladder.

The rise of the likes of China, India and Brazil is inevitable but this is no excuse for Europe to give up. The big question however is whether the UK and other like-minded governments, such as the Scandinavians, the Dutch and the Czechs, will be able to keep the eurozone's attention long enough to make the point.

For this to happen, the British government needs to roll up its sleeves and get down to business: form alliances (cultivate, cultivate, cultivate the Scandies, new members - and the biggest prize of them all - Germany), horse-trade, manage the European Parliament, convince through pursuing best practice at home (such as the 'Better Regulation agenda', and a strong, healthy economy), on EU proposals get in early and get in low - but be tougher and shrewder when negotiations get rowdy.

Downing Street should be given credit for raising its game on EU reform. But now it must show it can turn a catchy pamphlet into concrete action.

Law of averages

In a speech in Oslo today, EU President Herman Van Rompuy talked about the sound fundamentals of eurozone economies. He references the average growth of 2%, the average deficit of 4.5% and the strength of the euro as evidence for his claim.

To his mind these are the "basic facts".

Well, we think it might be worth reminding him of the basic nature of averages. If you have two very divergent groups (the core vs. periphery eurozone economies) the average will be somewhere in the middle and will be of little use – it may even be misleading.

Take two people, one about to fall off a cliff (Greece, Ireland, and Portugal) and another standing a fair distance away (Germany, Finland etc), on average their position from the edge of the cliff will not sound too bad but this misses the point that one of them is in dire straits. Add to this analogy the fact that the two are tied together by a rope (the single currency), and the situation clearly is not how it sounds under Rompuy’s becalming "basic facts" scenario.

As for the strong euro, this is another misleading point. It is being maintained by the spectre of imminent ECB rate rises, which would be detrimental to many of the peripheral eurozone economies – due to high private debt and lack of lending in the economy (not to mention encouraging further current account deficits). In our scenario this introduces a third person (the ECB) who is chipping away at the cliff beneath the first person’s feet (precipitating their fall).

To convey the basic facts of a system as complex as the eurozone you need to go deeper than averages.

How much longer can the eurozone live an alternate reality?

This week's fun and games are over, with EU leaders concluding their Brussels summit earlier this afternoon.

Once again, this summit is unlikely to be remembered for anything EU leaders could agree on but, rather, for what eurozone leaders, in particular, were unwilling to even discuss. Namely, getting to the root of sorting out the eurozone's short-to-medium-term future.

As the BBC's Paul Mason asks on his blog:

Why, within the space of 12 days, do we get a "grand bargain" to create a Euro Stability Mechanism (11 March), which is then (a) knocked back by Finland (b) defied by Portugal (c) renegotiated at the behest of Germany's FDP coalition partner so they can do a tax giveaway in the coming elections; and (d) excludes Ireland anyway?

Chancellor Angela Merkel's, and by extension Germany's, focus on what are, in the grand scheme of things, minor details is starting to betray a worrying resemblance to an obsessive-compulsive's inability to recognise the bigger and far more important realities in life. Merkel's two 'victories' from this summit appear to be the fact that Germany will now pay in its share of capital to the permanent post-2013 eurozone bailout fund over five years rather than four and an EU commitment to "stress test" nuclear power stations. These are both pretty obvious bones thrown to the domestic German audience - the SPD and Greens are breathing down the neck of Merkel's CDU party in important regional elections - but will do little to reassure people that the eurozone is serious about tackling its problems. Not for the first time, domestic politics is pitted against eurozone imperatives.

True, the proposals on economic governance and tighter fiscal discipline were broadly endorsed, but earlier German proposals have been watered down and there's still much to play for in regards to how much of the package will be credibly enforceable. How will Italy and Greece cope with demands to get their debt-to-GDP below the 60% threshold?

Partly also due to Finnish resistance, eurozone leaders were unable to reach agreement on how to top up the existing temporary bailout fund, which, with Portugal more or less in a state of political and economic crisis seems a little complacent to say the least. We're told that all will be settled at the next summit in June - but haven't we heard this before; "It will all be sorted next time, no need to worry".

Maybe Merkel and the rest of the eurozone's leaders just prefer working under pressure. June really will be cutting it fine: Portuguese elections are expected to have been held only a week or so before and the new attempt at credible stress tests for Europe's banks are due to be published.

How much longer can the eurozone live an alternate reality?

Portugal in Crisis after Prime Minister Resigns over Austerity Measures
THE GUARDIAN: • EU bailout closer after José Sócrates loses crucial vote • Political limbo will put pressure on Portuguese bonds

Portuguese prime minister José Sócrates has said he has submitted his resignation to the president after parliament rejected his minority Socialist government's latest austerity measures.

The loss of the vote "has taken away from the government all conditions to govern," Sócrates said. It brings the country closer to needing a bailout.

Sócrates is said he tendered his resignation to President Aníbal Cavaco Silva tonight, leaving the country in a political limbo that would place further pressure on Portugal's record-level bond yields.

Sócrates had said before the vote that he would resign if the measures to cut spending and increase taxes – designed to see off a bailout similar to those taken by Greece and Ireland – were rejected.

The measures had aroused the fury of trade unions, and railway engineers walked off the job in the morning, causing widespread travel disruption. » | Giles Tremlett in Madrid | Wednesday, March 23, 2011

THE GUARDIAN: Portugal bailout 'could cost UK £3bn': Bailout request seen as 'inevitable' following prime minister's resignation in wake of failure to push through austerity measures » | Graeme Wearden | Thursday, March 24, 2011

Will this make countries keener on joining the euro?

Negotiations on the shape and form of the eurozone's permanent bailout scheme - the "European Stability Mechanism (ESM)" - are entering a crucial phase. The fund is meant to be up and running by mid-2013 and is likely to have €500bn available. Of this amount, between €80bn and €100bn will be up-front cash from member states - the rest will come in the form of guarantees.

People are naturally getting nervous about this arrangement, particularly in Germany. Sueddeutsche suggested the other day that German taxpayers will need to contribute between €18bn to €25bn to the scheme in paid up cash (in addition to the guarantees).

Chancellor Angela Merkel isn't too keen on discussing how much Germany might have to contribute in the end. "She doesn't want to talk about this now", a diplomat reportedly said.

We can see why. A direct €25bn liability on Germany's books could increase the country's borrowing costs and hamper efforts to consolidate its budget.

To avoid this, the German government is pushing only for countries without a triple A rating to contribute paid-up cash, as triple A countries - so says Merkel - are lending their good name to the cause, and that's quite enough. But this, in turn, would increase the cash contributions from weaker eurozone members. This has raised alarm bells amongst weaker euro economies as well as a range of non-eurozone members.

Reuters yesterday quoted EU sources saying that eurozone members Estonia and Slovakia as well as Latvia, Lithuania, Bulgaria and the Czech Republic have all criticised the plans. They argue that basing cash contributions to the ESM on a country's proportion of the ECB's paid-up capital is unfair. The countries have even threatened to block proposals for tougher EU-wide budget rules unless changes are made to the suggested ESM arrangement. One representative said,

"Unless there is a change to the ESM capital key we will block the agreement on the governance package once it returns from parliament and EU finance ministers have to approve it by unanimity."

Also non-euro member Sweden has objected to the proposed capital key for the ESM.

Why do these countries feel so strongly about this issue. They're not in the eurozone after all? Well, probably because they understand that, were they one day to join, they could be forced to cough up actual cash to save a Greece, Ireland or Portugal. Paid up cash is a far more serious liability than loan guarantees. Slovakia's refusal to take part in the Greek bail-out gives a hint as to why these countries aren't thrilled by the prospect of a permanent bail-out arrangement linked to the ECB's capital key and credit status. In such an arrangement, smaller economies that haven't really done anything wrong could end up with a pretty hefty bill.

On a related note, where is the UK in all of this? So far, the UK appears to have taken little interest in the structure and pay-in arrangement of the permanent bail-out mechanism. If this is because it doesn't intend to ever join the euro, that's one thing.

But if it's because Britain thinks it has no stake in making sure that the new eurozone rules are fair and make economic sense - rather than facilitating even greater meltdowns down the road (a very real risk) - then the UK government is sadly mistaken.