Monthly Archives: January 2012

January 30, 2012 · 22:29

A Tombstone Treaty?

There is no doubt in this bloggers mind that the EU leaders eventually will agree on, and sign, a new fiscal Treaty for the euro zone. But the really interesting question is; will it actually work? Or will this be the document that buries the whole EU idea once and for all?

“The new Treaty provides little enhancement with respect to the Stability and Growth pact and includes measures that are either too vague or likely to be ineffective.”

Massimiliano Marcellino

Well, according to Professor Massimiliano Marcellino at the European University Institute it will not. “This is surely not the right moment to spend so much time in drafting a new treaty that does little to address the most pressing short-term problems of the euro area,” Professor Marcellino writes in a commentary, adding: “But let’s assume for a moment that the Treaty is approved, and without major modifications.”

It’s a perfectly timed commentary, and raises some of the really fundamental questions around the plans for a new fiscal Treaty amongst the euro zone members.

Here’s the rest of the article, published today at the www.eurointelligence.com:

Why We Don’t Need The New Fiscal Treaty

The first goal in the treaty is to “foster budgetary discipline” and Title III of the draft treaty introduces measures aimed at achieving this target.

The key economic indicators used in Title III are the structural balance of the general government, which is required to be balanced or in surplus, and the ratio of the general government debt to gross domestic product (GDP), which in the long run should not exceed 60%, and if it does it should be reduced by an average rate of one twentieth per year.

The problem of a target in terms of structural balance is that this variable is not observable. It must be constructed by cyclically adjusting the actual balance.

There is no consensus about how to measure the business cycle even among economists,  so it can be expected that member states will have very different opinions about the state of their business cycle and hence about the meaning and measurement of “structural balance”.

In addition, it is not obvious from an economic point of view that growth promoting expenditures, such as investment in education and research, should be included in the computations.

Equally problematic is the debt to GDP ratio, considered by many as the prince of fiscal indicators.

However, it is a strange indicator: in the numerator there is a stock variable, the total amount of government debt, and in the denumerator a flow variable, the gross domestic product in a given period.

The latter is considered as an indicator of the capability of the government to repay its debt. But to reflect fully the financial conditions of a government, it would also have to include a measure of the total government assets.

In addition, the value of 60% for the debt to GDP ratio, inherited by the Stability and Growth pact, does not have any serious economical basis. And there seems to be little awareness that reducing the debt to GDP ratio by one twentieth per year, it would require continuous tightening of fiscal policy with negative effects on GDP growth, which would make this policy ineffective while the economic conditions of the country worsen.

Much more preferable are thus targets defined in terms of actual deficits, ratios of debt not only to GDP but also to assets, and more gradual convergence criteria.

The main concern remains however, namely that the procedures in case of a breach of the rules remain very long and complicated, and that the penalty system is unclear and insufficient to prevent future misbehaviour, in particular in the case of a large country.

The second goal of the new Treaty is “to strengthen the coordination of economic policies“, article 9 states that “… the Contracting Parties undertake to work jointly towards a common economic policy fostering the smooth functioning of the Economic and Monetary Union and economic growth through enhanced convergence and competitiveness”.

To this aim, article 11 clarifies that “With a view to benchmarking best practices and working towards a common economic policy, the Contracting Parties ensure that all major economic policy reforms that they plan to undertake will be discussed ex-ante and, where appropriate, coordinated among themselves.”

Here there is quite a bold statement: to work jointly towards a common economic policy.

Taken literally, this has major implications.

But how can we expect that member states are ready to do this after they so utterly failed in the past?

And does this imply that national parliaments should partly give up their authority?

And what happens in case of disagreement on how to foster growth or convergence?

And what is the actual role of other European institutions such as the European Parliament?

Finally, in terms of governance of the euro area, the Euro Summits are welcome but, according to their description in Title V, they seem to be just discussion fora, and in this sense their value added with respect to other existing fora is not clear-cut.

Massimiliano Marcellino

The new Treaty provides little enhancement with respect to the Stability and Growth pact and includes measures that are either too vague or likely to be ineffective.

It also fails to address the current crisis.

Financial markets are more worried about short and medium term solvency than about the enhanced long-term sustainability and policy coordination.

Without bolder actions to prevent a break-up of the euro area this new Treaty is likely to become redundant.

Massimiliano Marcellino is professor at the European University Institute in Florence.

This article is syndicated by www.eurointelligence.com.

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January 29, 2012 · 23:11

Strongest Solar Storm Since 2003, Flights Rerouted

The strongest solar storm since 2003 started last Monday – a wave of charged particles from an intense solar flare eruption is now raising alerts about airline flights and satellite operations. The solar flares did not make a direct hit on the Earth, but several flights were rerouted last week and scientists are not sure if there will be more to come.

“The chance for re-intensification is still possible because this active spot on the sun that created the initial havoc could go off again.”

Harlan Spence

The storm began when a powerful solar flare erupted on the sun Monday, blasting a stream of charged particles toward our planet. This electromagnetic burst — called a coronal mass ejection, or CME — started hitting Earth somewhere around 10 a.m. ET Tuesday, according to the National Oceanic and Atmospheric Administration’s Space Weather Prediction Center.

Experts at the center says that solar radiation levels were at their highest point since the Halloween storms of 2003.

Earlier estimates ranked the storm as the strongest since 2005 in terms of solar radiation, but Terry Onsager, a physicist at the Space Weather Prediction Center, said that when the wave of charged particles arrived, “that took it from below the 2005 event to above the 2005 event,” msnbc.com reports.

Bill Murtagh, the center’s program coordinator, said that the outburst was forcing airlines to change routes for some of their scheduled flights. “Most of the major airlines flying polar [routes], or even some non-polar, high-altitude routes, have taken action to mitigate the effect of this storm,” he says.

Airline Alert

Delta Air Lines reported that it altered routes for “a handful” of flights, and that the changes added about 15 minutes to travel times.

Delta spokesman Anthony Black told Reuters that solar activity “can impact your ability to communicate … so basically, the polar routes are being flown further south than normal.”

United Airlines says one flight was diverted on Monday, while American Airlines says it has seen no operational impact from the storm so far but was monitoring the situation.

As powerful as it is, the storm should have no effect on daily life for most people, msnbc.com writes.

No Direct Hit

When a coronal mass ejection hits Earth, it can trigger potentially harmful geomagnetic storms as the charged particles shower down the planet’s magnetic field lines.

This can amp up normal displays of Earth’s auroras (also known as the northern and southern lights), but a strong CME aimed directly at Earth can also cause disruptions to satellites in orbit, as well as power grids and communications infrastructures on the ground.

Monday’s solar flare set off an extremely fast-moving CME, but the ejected cloud of plasma and charged particles was not directly aimed at Earth and hit the planet at an angle instead.

This glancing blow would likely lessen any impacts on Earth,

“Earth’s magnetic field served as a shield, and pretty much shielded the radiation so that it doesn’t penetrate that deep,” Yihua Zheng, a lead researcher at NASA’s Goddard Space Flight Center says.

“It’s like a car collision: head-on or off to the side. A CME is like that too. For this one, if it was a direct hit, Earth would receive a much stronger impact. This one was on an angle — toward higher latitudes and a little off the ecliptic — otherwise it would be a much stronger impact.”

Several NASA satellites, including the Solar Dynamics Observatory, the Solar Heliospheric Observatory and the STEREO spacecraft, observed the massive sun storm.

Data from these spacecraft were combined to help scientists create models to calculate when and where the CME was going to hit Earth.

“A CME is kind of like a space hurricane,” Zheng says. “You have to predict how it will form and evolve. From the models, we can see which spacecraft will be in its path, and what will be impacted.”

At the Space Weather Center, scientists reported that the CME began interacting with Earth’s magnetic field at 9:31 a.m. ET. “We predicted it would arrive at 9:18 a.m., and in reality, it arrived at 9:31 a.m., so ours has a 13-minute error,” Zheng adds. “Usually for this kind of model, the average error is seven hours, so this is the best case.”

Subside or Intensify?

At NOAA’s Space Weather Prediction Center they say the level of solar radiation should gradually subside — unless the sun unleashes another big coronal mass ejection. “The expectation is that it will weaken and that it will decay over the next couple of days,” NOAA representatives told msnbc.com.

The University of New Hampshire’s astrophysicist Harlan Spence says “the chance for re-intensification is still possible because this active spot on the sun that created the initial havoc could go off again.”

The solar flare associated with this week’s storm was estimated to be an M9-class eruption, which placed it teetering on the edge of being an X-class flare, the most powerful type of solar storm. M-class sun storms are powerful but midrange, while C-class flares are weaker.

The flare erupted from sunspot 1402, a region near the meridian of the sun that has been active for a while now, according to NASA.

The powerful solar storm could be signaling that the sun is waking up after an extended period of relative dormancy.

The sun’s activity waxes and wanes on an 11-year cycle.

The star is currently in the midst of Solar Cycle 24, and activity is expected to continue ramping up toward the solar maximum in 2013.

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January 28, 2012 · 16:57

El-Erian On Markets Balance Solvency, Growth and Liquidity

Another week has passed by and more ugly signs of how deep our economic troubles are have emerged. The only thing that keeps our financial house of cards from collapsing is the endless stream of money coming from the central banks – primary the US Federal Reserve and the European Central Bank (ECB). But doubts about the final outcome still persist.

“The health of the global economy, and that of markets, depends on the success of a series of medium-term handoffs between the public and private sectors – in growth, balance sheets and credit flows. This week’s data highlighted their complexity.”

Mohamed El-Erian 

In spite of the massive injection of money into the financial system by the central banks, key economic indicators continue to disappoint.  And by now, the central banks have painted themselves into a corner where there’s little else to do. The global economy is practically in state of stagnation – the next stage is depression…

Mohamad El-Erian at PIMCO is one of the top leaders who have managed to keep his cool and not lose his head throughout this whole mess so far.

He openly admits he does not have all the answers, but as usually he points to some key factors that we all should be aware of.

Here’s his latest commentary, as published by CNBC today:

“The health of the global economy, and that of markets, depends on the success of a series of medium-term handoffs between the public and private sectors – in growth, balance sheets and credit flows. This week’s data highlighted their complexity. Fortunately for investors, the valuation impact is being compensated by central banks‘ wide open liquidity spigots,” El-Erian writes.

And continues:

To counter disorderly private sector de-levering and avoid an economic depression, governments and central banks around the world have aggressively ballooned their balance sheets.

This has helped heal some private balance sheets but job creation has remained very anemic, income inequality has increased, and growth has been too weak to allow for the de-levering of the public sector (including fiscal deficits and central balance sheets which now vary in size from 20% of GDP in the US to 30% in Europe).

In the US, Friday’s disappointing GDP print for the fourth quarter was a reminder of the challenge, especially in view of a less-than-reassuring composition.

Consumer growth was limited to just 2% notwithstanding yet another decline in the savings rate to 3.7%, a level last seen at the end of 2007. Export growth also decelerated. Indeed, were it not for a surge in inventory, the economy would have probably succumbed to the drag from government components.

The extent of the growth challenge in Europe was highlighted by Friday’s higher than expected increase in Spanish unemployment (to an agonizing 22.9%).

Meanwhile several of the region’s governments, ECB, IMF and private creditors continued to squabble about how to allocate the inevitable losses on Greek debt.

In Portugal, another highly vulnerable economy, market measures of default risk reached record highs this week.

The longer such solvency and growth indicators continue to flash red in Europe, the more likely that capital will continue to flee; and the harder it will be to overcome the region’s debt crisis.

Dr. Mohamed El-Erian is CEO and co-CIO of PIMCO, the bond investment house.

Read the full post at CNBC.

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