Full analysis of the G7 statement on Financial Markets

This post is archived. Opinions expressed herein may no longer represent my current views. Links, images and other media might not work as intended.

Markets remain volatile despite the rhetoric of politicians. Image source: The Telegraph

On August 7 the Finance Ministers and Central Bank Governors of the seven wealthiest industrialized nations, the so-called G7, issued a statement in which they say that they are ready to provide extra cash if markets seize up. I shall put down their final text, analyze it paragraph by paragraph, to see whether the statement is just promising political rhetoric, or whether it paves the road for real reforms. I found the original text on Credit Writedowns.  

(Note: the text that appears in a blockquote, i.e. that has a light gray background color and a black border-line on its left, is from the G7, the rest is mine) 

Starting from the first paragraph:

In the face of renewed strains on financial markets, we, the Finance Ministers and Central Bank Governors of the G-7, affirm our commitment to take all necessary measures to support financial stability and growth in a spirit of close cooperation and confidence.</p>

The opening phrase is inaccurate and misleading. It speaks about “renewed strains in financial markets”, as if the crisis is just financial. Well, it is partly financial. But mostly it is a crisis of the system, a crisis of ill-regulated movement of capital and financial institutions. A crisis of under-investment in the western world.

The next phrase about “supporting financial stability and growth” is vague and again can be misleading. It omits one very important dimension of the current structure of the crisis, i.e. the ineffectiveness of monetary policy that exists in the Eurozone. The eurosystem (the banking system of the euro) is quasi-bankrupt and functions as a black hole, since the European Central Bank (ECB) supports private banks with oceans of liquidity, assuming that those will end up in the real economy, but because banks face existential problems, use that money to re-capitalize, thus only a small margin of the original amount ends up in the market. As for the word “growth” this has been heavily misused and has eventually lost its true meaning.

We are committed to addressing the tensions stemming from the current challenges on our fiscal deficits, debt and growth, and welcome the decisive actions taken in the US and Europe. The US has adopted reforms that will deliver substantial deficit reduction over the medium term. In Europe, the Euro area Summit decided on July 21 a comprehensive package to tackle the situation in Greece and other countries facing financial tensions, notably through the flexibilisation of the EFSF. We are now focused on the quick and full implementation of the agreements achieved. We welcome the statement of France and Germany to that effect. We also welcome the statement of the Governing Council of the ECB.</p>

The so-called “decisive actions” are nothing more than semi-measures that succeed only in buying time. Serious reforms are still needed to address the deep-seated problems that cause the crisis. The US have adopted reforms that however fail to deliver any substantial solution to the real problems of the US economy. Real growth is extremely weak, unemployment is very high, inflation is also a destabilizing factor. Moreover nothing was done to shift the trade balance, nor was anything decided to regulate the financial sector.

As for the Euro area, I have written a series of articles on the Euro Crisis where I explain the serious flaws in both the architecture of the eurozone and in the measures that European leaders have adopted so far. In short, European leaders fail from the outset to understand the very structure of the crisis. They treat it as a debt crisis of certain “indisciplined” member-states (the “PIIGS”), when in fact the crisis is systemic and is much more than a mere debt crisis in certain states. It is a triple crisis comprised of (a) debt crisis, (b) quasi-bankrupt banking sector crisis, (c) under-investment crisis, especially in the European periphery. Additionally, European leaders do not want to accept the systemic flaws of the single currency and the lack of stabilizing mechanisms such as fiscal transfers. Nor do they want to revise the role of the ECB, the EIB and the need to create a fiscal union within that context.

As for the July 21 summit of the heads of state and government of the Euro area countries, it has massively failed to address the fundamentals of the crisis. It is nothing more than a continuation of the same failing practices that have so far worsened the crisis and that have massively failed to contain contagion. Soon enough (even before the end of this year) another summit will be required to find solutions to the problems that were not addressed and to revise this summit’s decisions as well (see my Full analysis of the outcomes of the EU summit).

Regarding the European Financial Stability Facility (EFSF), I have written an analysis in which I explain that its size or its “flexibilisation” does not really make it more effective, since the current structure of the EFSF is highly toxic and is the source of contagion. The main reason why that is the case, is that quasi-bankrupt and hardly-pressed states are called to bail out their bankrupt partners, thus making their own position much more difficult and much more prone to contamination. For instance Spain, Italy and Cyprus that are seriously threatened by market pressures and might come to the need of a bailout now have to give part of their resources to fund a second bailout to Greece.

We are committed to taking coordinated action where needed, to ensuring liquidity, and to supporting financial market functioning, financial stability and economic growth. </p>

The focus on liquidity is false. The Fed and the ECB have been pumping money but this has had a negligible impact on the crisis. Either they like it or not, there needs to be a massive restructuring of the debt of banks, since any money that is now given to them is only used to sustain them. Moreover this unlimited support to banks, does not offer any incentives for real changes. It just sustains the losers. Bankers too, must realize that they are accountable for their risky actions and understand that if they make the wrong choices they will have to bear the cost. Maintaining zombie banks only rots the system.

These actions, together with continuing fiscal discipline efforts will enable long-term fiscal sustainability. No change in fundamentals warrants the recent financial tensions faced by Spain and Italy. We welcome the additional policy measures announced by Italy and Spain to strengthen fiscal discipline and underpin the recovery in economic activity and job creation. The Euro Area Leaders have stated clearly that the involvement of the private sector in Greece is an extraordinary measure due to unique circumstances that will not be applied to any other member states of the euro area.</p>

“Fiscal discipline” is the euphemism used to describe the self-defeating strict austerity policies that have become the canon in dealing with the crisis. The so-called fiscal consolidation (fiscal discipline/austerity) has the effect of shrinking the economy, of increasing unemployment, of making things worse. In an economy that has been structured to a certain extend on government spending, it is catastrophic to draw out that significant part of spending. Most countries in Europe are structured in that way, thus the kind of policies that they are now adopting deprives their economy from growing.

Nobel Laureate Prof. Paul Krugman has said on the issue: “Why not slash deficits immediately? Because tax increases and cuts in government spending would depress economies further, worsening unemployment. And cutting spending in a deeply depressed economy is largely self-defeating even in purely fiscal terms: any savings achieved at the front end are partly offset by lower revenue, as the economy shrinks. So jobs now, deficits later was and is the right strategy.”

Finally in yesterday’s article I wrote about the myth that exists around the private sector involvement in the Greek crisis. To understand why check my article titled An evaluation of the myth of the 21% haircut on Greek bonds.

We reaffirmed our shared interest in a strong and stable international financial system, and our support for market-determined exchange rates. Excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability. We will consult closely in regard to actions in exchange markets and will cooperate as appropriate.</p>

We will remain in close contact throughout the coming weeks and cooperate as appropriate, ready to take action to ensure stability and liquidity in financial markets.

The above are the concluding remarks from the statement of the G7. So far I believe that you are able to understand how empty those words are.

Policy makers are sticking their heads in the sand. Real solutions need to be delivered. Those require audacious reforms, that can only come with political vision and courage, both of which are absent in today’s political order.