Can There be Reason for Optimism in the Eurozone?

by Elliott Morss


It was interesting that on Friday, the talking heads and stock markets were quite bullish on developments in the Eurozone. What really happened last week? We had two changes of government and a new “weak sister” came into view. Until last week, I had been calling Greece, Ireland, Portugal and Spain the “weak sisters’. And now, with nobody interested in Italian bonds, there are five. New governments in Greece and Spain? Is this a reason for optimism? Here is my guess on how things will go: they will try to implement the harsh austerity measures demanded ECB/IMF. This will cause higher unemployment and severe political instability.

What the ECB/IMF Is Demanding

We all have heard general statements on ECB/IMF austerity demands that governments cut their deficits by cutting expenditures and increasing taxes. But there is much more than this. To give some sense of the magnitudes of the ECB/IMF demands, I copy from the IMF Fourth Review of its Standby Agreement with Greece.

“The problems of public finance that Greece is confronting—a weak revenue administration, bloated public employment, untargeted social support, a fragmented and oversized public administration—are not easy to overcome….”

Among other things, the ECB/IMF is demanding Budget Administration reforms and new fiscal actions to turn things around. An abbreviated list of the requested fiscal reforms follows:

  1. Reduce the government deficit
  2. Rationalize the public wage bill
  3. Reduce public employment
  4. Reduce contract employment
  5. Adjust public employees’ compensation
  6. Create a single public sector wage scale
  7. Reduce automatic “wage drift”
  8. Close non-essential public entities and agencies
  9. Reduce grants to entities outside the general government
  10. Improve the performance of state enterprises
  11. Increase tariffs and other revenues
  12. Reduce personnel and other costs
  13. Streamline and better target social benefits
  14. Strengthen means testing, and review social benefits
  15. Pension reforms, including supplementary pensions, lump sum pensions and instability pensions
  16. Health sector reforms, including central procurement system, pharmaceutical spending Elimination of tax exemptions and special tax regimes
  17. Increases in contributions
  18. Reduction in the tax free PIT threshold
  19. Increase property taxation, including reduction in tax free threshold, increased rate and assessment
  20. Increased minimum tax on self employed
  21. Social Security reforms, including increases in social security contributions (not related to pensions), improvement in the administration of taxes and social security contributions, improvements in revenue administration, and improvements in the administration of social security contributions
  22. Improved  government performance, including reduction in operational defense expenses Improved performance of local governments
  23. Rationalization of the public investment budget
  24. Economic system reforms, including liberalization of tourist coaches
  25. Liberalization of the energy sector
  26. Liberalization of tourism and the retail sector
  27. Simplification of export procedures
  28. Simplification of environmental licensing
  29. Simplification of regulations to boost investment
  30. Clearing the existing case backlog in courts
  31. Reviewing the Code of Civil Procedures

In order to achieve these objectives, the Greek government has agreed to foreign technical assistance in the following fields:

—Banking supervision

—Public financial management

—Revenue administration

—Data quality and misreporting

—Expenditure policy

—Public financial management

—Implementation of financial sector components of the SBA program

—Tax administration:

  • Design of the anti-evasion plan
  • Implementation of the anti-evasion plan
  • Implementation of financial sector components of the SBA
  • Implementation of public financial management
  • Implementation status of priority reforms
  • Monitoring of fiscal data for the program
  • Monitoring anti-evasion and structural reforms
  • Monitoring health system analysis and proposals
  • Monitoring government finance statistics
  • Defining role of accounting officers
  • Monitoring government finance statistics/fiscal reporting
  • Implementing strategic tax planning
  • Monitoring public financial management
  • Follow up on implementation of priority reforms
  • Management of general tax policy
  • Management of  financial instruments
  • Review of the legal and operational framework for bank resolution
  • Review of taxpayer audit.

Why do I present these lists of details? Because it is important to understand what Greece and the other weak sisters are being asked to do. Will it work? Will the countries put up with all these consultants and reforms until fruition? Not likely.

Bank Runs and Capital Flows

In my last article, I suggested that bank runs are likely. Der Spiegel has just published a 3-part article titled “Run for your Lives”. It finds that large amounts are being withdrawn from Euro banks:

“Since the beginning of the crisis, ordinary Greeks have withdrawn about €50 billion ($69 billion) from their accounts, or a fifth of total deposits…. Switzerland is a popular safe haven. The Greeks have reportedly deposited about €280 billion in Swiss banks. This capital flight has triggered a boom in the European real estate market, especially in Berlin and London, where wealthy Greeks are buying second homes. The Italians are also getting nervous. Figures compiled by the German Bundesbank and the Banca d’Italia, Italy’s central bank, suggest that more than €80 billion in capital was moved out of Italy in August and September…. by Italians concerned about the growing risk of a government insolvency.”

Yesterday (November 14) even Warren Buffett had some remarks about European bank runs.


In all my recent articles on Eurozone problems, I have argued that the weak sisters should leave the Eurozone because they cannot compete with Germany et al. Evidence on this is reported in the Der Spiegel pieces referenced above. According to an unpublished study by the Ifo Institute for Economic Research, “prices of goods produced in Greece went up by an average of 67 percent between 1995 and 2008, a record increase for the euro zone. The average price of domestically produced goods went up by 56 percent in Spain, 47 percent in Portugal and 41 percent in Italy. By contrast, prices went up in Germany by only 9 percent in the same period.”

ECB Bond Purchases

For weeks, I have been trying to get a breakdown on ECB purchases of weak sister debt. I have just been informed by the Bank that “please kindly note that requested information from the ECB is not for public use.” Interesting.  Whatever happened to transparency? Anytime you want to see what the Federal Reserve has bought, you just go to the FRB site. The following picture appeared in the Der Spiegel piece. Clearly, the ECB is trying to contain the situation.

But ECB dynamics are very different from the Fed. While the Fed will do all it can to get the US out of the recession, the Germans do not want the ECB used in that manner. I quote again from Der Spiegel:

“Obama proposed that the Europeans follow the example of the American Federal Reserve….” The Germans pointed out feebly that the ECB operates within a completely different tradition than the Fed….” But it is becoming increasingly clear to Merkel and her finance minister that, in the end, only the ECB will be able to save the euro if the crisis continues to escalate. Most European leaders have nothing against using the central bank’s reserves as a source of financing, as became evident at the Cannes summit…..But Bundesbank President Weidmann was deeply troubled….The Bundesbank fears that issuing the special drawing rights would open yet another door to monetary state-financing.”


The answer to the title question?  No.  The Euro crisis will deepen.  The next “surprise”?  We have not heard much from Spain recently.

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