Wednesday, March 24, 2010

Hungary urges Europe to help Athens

Hungary urges Europe to help Athens
By Stefan Wagstyl, East Europe editor

Published: March 23 2010 18:43 | Last updated: March 23 2010 22:14

Hungary, the first European Union country to seek International Monetary Fund support in the crisis, has backed moves to allow Greece to follow suit.

In an interview with the Financial Times, Gordon Bajnai, prime minister, urged EU leaders to give Athens “breathing-space” and help it access IMF loans. Speaking before a European summit where Greece tops the agenda, Mr Bajnai said: “From the position of ‘been there, done that, got the lousy T-shirt’, I can say that Greece does need the sort of solidarity that Hungary has received.”

The Hungarian leader was referring to a combined IMF/EU $25bn (€18bn, £17bn) rescue package that Budapest secured in 2008 which was followed by similar deals for other troubled east European economies.

Mr Bajnai said if the EU could not itself help Greece, Athens should go the IMF. “If the European Union doesn’t have the institutions at the moment ready to provide that assistance, if there is no immediate political agreement on establishing those institutions or even on a co-ordinated effort [inside the EU], then Greece will be better off having the IMF.”

The premier said Hungary’s experience showed that countries which embarked on crisis-driven reforms, as Greece was doing, needed time to restore financial confidence. “Confidence is like the air. As long as you have confidence you don’t realise how important it is. When you miss confidence or you miss air then you start to choke. That is what is happening with Greece.”

The prime minister, who has spearheaded IMF-backed economic reforms, said Hungary had lessons for Greece. First, reforms must be big enough to be convincing. “You have to cut deep enough. Like the surgeon in the battlefield who can’t be compared to the plastic surgeon who is measuring every millimetre. The surgeon in the battlefield has to cut deep enough to make sure the wound is not killing the patient.”

Next, reformers should begin with big changes, so they could use their initial political capital. They should set “measurable targets” and subject them to external scrutiny. Finally and most importantly, reformers should secure “basic social acceptance”.

Greece had passed all these tests except the last, said Mr Bajnai. But it was easier to win public support in Hungary, where there were 1.7m foreign exchange loans covering homes, cars and electronic equipment. Hungarians saw “the fundamentals of their lives were at stake” if confidence fell and the currency collapsed. Eurozone residents were not so exposed to such fears – making life harder for their politicians, said the Hungarian leader.

Mr Bajnai was brought in as a technocratic prime minister after the failure last year of a centre-left Socialist government. He is standing down after next month’s parliamentary election, which is expected to see victory for the opposition centre-right Fidesz grouping. Mr Bajnai does not expect the new government to make radical economic changes.

Challenges on growth and jobs

Hungary fell into economic trouble before the global crisis, owing to mounting budget deficits and spiralling government debt. Public confidence collapsed after Ferenc Gyurcsany, the Socialist former prime minister, admitted lying about the economy to win the 2006 election.

Hungary secured a $25bn rescue from the European Union and the International Monetary Fund in 2008 linked to tough reforms, including pension and welfare cuts, increases in retirement ages and reductions in labour taxes, combined with a swingeing fiscal reform that saw the budget deficit drop from a 9.2 per cent peak in 2006 to 3.9 per cent last year.

Mr Gyurcsany quit last spring, giving way to Gordon Bajnai’s technocratic administration. Recovering global confidence helped lift Hungary from the financial danger zone: Budapest stopped drawing down IMF loans last July and returned to the market. But challenges remain, including generating growth, cutting social spending and persuading more people to work – the current employment rate is just 56 per cent, low by EU standards. Gross domestic product, down 6.3 per cent last year, is forecast to grow slightly this year and by 3-4 per cent in 2011.

Europe: Defiant in Berlin
By Ralph Atkins in Frankfurt
Published: March 23 2010 22:17 | Last updated: March 23 2010 22:17

“I am a Bayern Munich fan. During the group phase of the Champions League, when Bayern had twice looked really bad against Olympique Lyon, I thought that if only Lyon would play a little less well, Bayern would have an easier time. But this is not the basis on which we can build a competitive system.”

Like a football manager, Wolfgang Schäuble, Germany’s finance minister, is reluctant to give rivals an edge. With Germany among the 16-country eurozone’s best performing economies as the region emerges from recession, he sees little reason to cede its advantages as a star striker.

But while such an attitude might be right on a sports pitch, Mr Schäuble’s comments in the Bundestag, or lower house of parliament, have been creating exasperation elsewhere in Europe. As the aftermath of the financial crisis moves into a new phase in which concern focuses more on the wider real economy and public finances than on banks and other stricken sectors, Germany faces accusations that it is no longer a team player.

Angela Merkel, chancellor, will arrive at Thursday’s European Union summit in Brussels under pressure not only over Berlin’s reluctance to help Greece, the fellow eurozone member where worries about public finances have been most acute. With the eurozone facing its most tumultuous period since the single currency was launched in 1999 – and one that could determine its fate – Germany is being called on to take a lead in boosting growth across the region.

After intensive fitness training in the years prior to the global crisis, German exporters were quick to benefit from the economic upswing that followed. But with the government also keeping a firm hand on the budget, and the country’s consumers as cautious as ever, domestic demand has not kept pace – meaning the impulse to European growth has been small. Mr Schäuble’s speech followed a Financial Times interview in which Christine Lagarde, France’s finance minister, went public with her criticism, asking whether countries running large trade surpluses – for which read her eastern neighbour – could not “do a little something”.

Until late last year, eurozone membership was a source of comfort, especially for smaller countries, which were sheltered from exchange rate crises. European solidarity – the dream of much of the continent’s political class since the second world war – appeared to have become a reality, even though it remained a monetary and not a political union. Now, the debate over Germany has exposed a potentially disastrous flaw in the 11-year-old eurozone.

For the weaker performing countries – particularly in southern Europe – monetary union has become a straitjacket. Greece’s travails have heightened the risks of a eurozone break-up. Given the scale of the task in matching Germany’s success, the danger is that the tensions will only grow worse.

With currency devaluation not an option, Germany’s stubbornness leaves other countries no option but to follow its competitiveness-focused strategy and binding fiscal rules. “If you don’t, you are raising your hands and saying, ‘I want to get out of the euro’,” says Jacques Delpla of the Conseil d’Analyse Economique, which advises the French government.

That is not how it is seen in Germany. It is a country whose successes were hard won. In the first half of the last decade, the Social Democrat-led government of Gerhard Schröder faced social unrest as it forced through structural reforms to curb public spending and boost labour market competitiveness. Now, many Germans argue, it is other countries that need to make changes.

Analysts also dismiss calls that Germany could change its behaviour overnight. “We are not living in a centrally planned economy,” says Jörg Krämer, chief economist at Commerzbank in Frankfurt. “Germany cannot change its model, because it is the model of millions of individuals and companies.”

Germans also reject the idea that they failed to shore up domestic demand. During the worst periods of the economic crisis, subsidies for short-time working prevented a steep rise in unemployment. Berlin’s pioneering “cash-for-clunkers” subsidies for new car sales, copied by the US among other countries, meant that even though the German economy overall contracted by 5 per cent last year, consumer spending actually rose. Real personal consumption was up by 0.3 per cent, compared with a 0.6 per cent fall in the US. Germany’s trade surplus declined significantly last year. “Germany was able to serve as an important buffer for world demand,” argued Axel Weber, Bundesbank president, in a speech in Denmark on Monday.

To strengthen their defence, German policymakers also point out that even Europe’s largest economy cannot transform the region’s prospects alone. Stronger German growth would boost demand for imports from France, say, lifting the French economy as well. But such gains are likely to be modest. According to the London-based National Institute of Economic and Social Research, whose economic model is widely used in Europe’s finance ministries and central banks, a 1 per cent increase in German gross domestic product lifts French GDP by just 0.2 per cent in the first year. Even then, there would be a downside. Faster growth in Germany would almost certainly lead to interest rates rising faster.

The European Central Bank’s view is that in the first decade of monetary union, the bloc’s biggest member was making up for the competitiveness it had lost in the years after the unification of east and west Germany in 1990. Jean-Claude Trichet, ECB president, told the European parliament on Monday that Germany’s trade surpluses were also a way of saving to pay for a rapidly ageing population.

Thus faster German growth would heighten the ECB’s fears of higher inflation. Even if the ECB held back, market interest rates would probably rise. For the French Treasury, higher borrowing costs would more or less wipe out the beneficial effects on revenues of stronger German growth, according to the NIESR model. “Even in a monetary union, you have to put your own house in order. You can’t expect others to do it,” says Ray Barrell, its director of forecasting.

As a result, eurozone countries’ economic fates lie in their own hands. The risk is of a damaging beggar-thy-neighbour contest to deflate costs (with Germany winning on penalties).

“Other countries are forced to reduce their wages, which means Germany will lose competitiveness. So what are the Germans going to do?” asks Paul De Grauwe, professor of economics at Belgium’s Leuven university. “Their model, which they are so proud of, will dwindle ... Too many countries want to build their model on export surpluses – and that is not a model that will lead to domestic demand and growth.” Worse, the pressure from financial markets created by the crisis over Greece may force other governments to slam the brakes on spending just when their economies are at their weakest, thus further undermining recovery prospects.

Is it really all doom and gloom? Not necessarily. Germany’s economy might adjust automatically. Mr Delpla at the Conseil d’Analyse Economique points out that as a result of wage moderation, corporate profits have risen to about 40 per cent of GDP – much higher than most European countries. Some kind of rebalancing appears inevitable, as “German trade unions will become angry about not seeing their wages go up”, he says.

Mr Weber argues that Germany’s past export success was “boosted by strong but ultimately unsustainable global economic growth” that is unlikely to be repeated, adding: “German enterprises will naturally have to focus more on the domestic market than before.”

Elsewhere, prices may fall, helping other countries regain competitiveness. “It will be cheaper for a German to go on holiday in Greece or buy a house in Spain,” says Mr Delpla. The ECB and European Commission are keen that eurozone countries seize the moment to embark on labour market reforms that increase cost efficiency and flexibility.

The worry is that inflexible European economies will take too long to adjust, risking social conflict and political tensions. Germany’s experience in the past decade shows it can take years to restore competitiveness within Europe’s monetary union, in which exchange rates are fixed – and the global environment at the time was much more favourable.

Germany’s lead might, moreover, simply prove too great for others. Until last year, when pushed sharply higher by the collapse in production, its unit labour costs had barely risen in a decade. Over the same period, these had risen in Spain, Ireland and Greece by 25 per cent or more. Even France showed a nearly 20 per cent increase.

“The magnitude [of the adjustment needed] is so big that it is going to be extremely long and painful – especially if we are in a very low-inflation environment,” says Jean Pisani-Ferry of the Brussels-based Bruegel thinktank. “If German wages are frozen, it is almost hopeless what you can achieve in a country like Spain.”

Fragile economic growth could also exacerbate weaknesses in the eurozone financial system. For the first decade of the euro, sluggish growth in Germany meant eurozone interest rates were set at a level that now seems to have been too low to prevent house price bubbles in countries such as Spain and Ireland. Now, the situation has reversed and, in setting interest rates for the region as a whole, any rises risk squeezing the weaker countries even more. Monetary union means “you have to set interest rates for the average – but the average is purely some statistic. There is no reality behind it,” says Mr Pisani-Ferry.

Mr Krämer at Commerzbank says the next few years may see the eurozone becoming more of a “transfer union” – in which better performing countries have to help out weaker members. “That could mean Germany says, ‘we are no longer willing to support the weaker parts of the EU’, and the Greeks say that they are not prepared to have policy dictated by the Germans,” he adds. “The risk cannot be totally excluded of a eurozone break-up within 10 to 15 years – and this is a consequence of widening eurozone divergences.”

If that risk rose, Europe would be facing a very different ballgame.

Shopping list of boosts

Berlin could boost demand in several ways. Tax cuts would put more money into the hands of consumers – as would higher public or private sector wages. Germans could also be persuaded to save less, although it is not clear how. Besides, any fiscal recklessness might simply scare them into saving more.

José Manuel Barroso, European Commission president, this week told the Financial Times that – rather than massive state spending – pension reforms, more e-commerce and relaxed shop opening hours could be used to stimulate demand. But when shop hours were liberalised in 2003, consumer spending barely moved that year or the next.

The other side of the surplus

Reeling from a double blow, Spain struggles to regain balance:

It is an ingenious scheme. Using a combination of windmills and water pumps, El Hierro, one of Spain’s Canary Islands, is destined by 2011 to produce all its own electricity with a €64m renewable energy project backed by the state, writes Victor Mallet.

The regional government is also trying to attract biotechnology investment and call centres. “The idea is to diversify the economy, to change the economic model based on construction and tourism,” says the archipelago’s investment promotion agency.

Such efforts are being replicated all over Spain in an attempt to rebalance the struggling economy. Having become too dependent on the income and low-quality jobs generated by the home construction and tourism industries, it is suffering from a double blow: the collapse of its domestic housing boom combined with the global economic crisis.

The Socialist government of José Luis Rodríguez Zapatero, prime minister, is preparing a “sustainable economy law” designed to wean the country off old industries and promote innovation, high technology and renewable energy.

But with many countries with lower costs doing the same, economists doubt Spain will be able to transform its economy fast enough to avoid a prolonged period – perhaps five years or more – of sluggish growth and painful adjustment as it tries to regain the competitiveness lost over the past decade of wage rises.

It has its advantages, not least a new transport infrastructure; a handful of globally competitive companies such as Inditex, the clothing company that owns the Zara brand; and some of the world’s best business schools.

But it also has an inflexible labour market; an unemployment rate of nearly 20 per cent – one of the European Union’s highest; and an onerous bureaucracy that deters entrepreneurs. Education is in dire need of reform. Nearly a third of Spaniards aged 18-24 have completed only compulsory schooling up to the age of 16, double the EU average. Only Malta and Portugal are worse. That is why it could take years to turn the economy around, even if the government can restore foreign confidence by cutting the budget deficit as planned from more than 11 per cent of gross domestic product last year to 3 per cent in 2013.

Spain, says one senior civil servant, has a “crisis with special characteristics” because the need for urgent domestic reforms has coincided with the global downturn. “We are correcting things in the most adverse conditions imaginable,” the official says.

German focus ‘will shift to domestic market’
By Ralph Atkins in Frankfurt
Published: March 22 2010 23:30 | Last updated: March 22 2010 23:30

Germany is unlikely to repeat its past export-led success and will have to focus more on the domestic market, its central bank president argued.

In the latest attempt to counter criticism of the country’s lopsided growth model, Axel Weber, Bundesbank president, argued that prior to 2008 German exports had been boosted “by strong, but ultimately unsustainable, global economic growth”.

In a future world environment “characterised by a less steep but hopefully healthier expansion, German enterprises will naturally have to focus more on the domestic market than before”, he said in a speech in Copenhagen.

His comments followed criticism last week by Christine Lagarde, France’s finance minister, that countries running large trade surpluses such as Germany were not doing enough to support growth across Europe. Her comments have riled German politicians, who have also appeared isolated within the 16-country eurozone over their reluctance to back financial aid for Greece.

German exports allowed the country to exit recession last year in advance of other large industrialised economies, with its companies reaping the benefits of years of wage moderation and structural reforms before the global financial crisis.

Mr Weber said policymakers would be “ill-advised” to conclude from Germany’s past performance that there was “the need for actively propping up domestic demand, for example via encouraging higher negotiated wages”. In fact Germany had served “as an important buffer for world demand at the height of the financial crisis via its still robust private consumption as well as large fiscal stimulus packages”.

The Bundesbank president added that attempts by politicians to co-ordinate an economic adjustment within Europe would be “neither necessary nor helpful”.

His case received backing from Jean-Claude Trichet, European Central Bank president, who told the European parliament in Brussels that there was no case for criticising countries running trade surpluses. The ECB president added the eurozone overall was in balance and had not contributed to “a disequilibrium at the global level”.

Excessive virtue can be a vice for the world economy

By Martin Wolf
Published: March 23 2010 20:19 | Last updated: March 23 2010 20:19

Germany says “nein”. That is the most important conclusion to be drawn from the debate on eurozone economic policy. What the German government is saying is that the eurozone must become a greater Germany. But this policy would have profoundly negative implications for the world economy.

This week’s letter to the FT from Ulrich Wilhelm, state secretary and government spokesman, and last week’s article by my friend, Otmar Issing, former board member of the European Central Bank, are significant not only for what they say but for what they do not say.

The point they make is that Germany will not risk undermining its competitiveness. The point they do not acknowledge is that the world economy has a difficult adjustment ahead, to which the eurozone and Germany need to contribute.

On the first point, Mr Issing is quite clear: “Following years of divergence between unit labour cost and losses in competitiveness in a number of countries, the idea is gaining ground that the economy with the biggest surplus, Germany, should help by raising wages in the interests of deficit countries and the community as a whole.” On the contrary, he insists, wages even in Germany are still too high, given the elevated unemployment.

I find it hard to disagree. Many countries entered the currency union without recognising the implications for labour markets. Rather than the reforms membership requires, they enjoyed a once-in-a-lifetime party. The party is over. With German unit labour costs stagnant and the euro still strong, labour costs in peripheral European countries must fall sharply. These countries have no alternative, within the currency union they chose to join.

On the second of the two points, however, Mr Wilhelm offers a disturbing paragraph: “The key to correcting imbalances in the eurozone and restoring fiscal stability lies in raising the competitiveness of Europe as a whole. The more countries with current account deficits are able to increase their competitiveness, the easier they will find it to decrease their public and foreign trade deficits. A less stability-oriented policy in Germany would damage the eurozone as a whole.”

I find it impossible to agree. What is fascinating about these remarks is that there is no mention of demand. Mr Wilhelm is inviting everybody to join a zero-sum world of beggar-my-neighbour policies in which every country tries to grab market share from the rest. At a time of global weakness, this is a self-defeating recommendation for both the eurozone and the world.

More precisely, what Germany wants to see is a sharp cutback in fiscal deficits throughout the eurozone. With the fiscal deficit contracting and output weakening, the way out for each country would be via falling relative unit labour costs and higher net exports. If successful, this would shift each country’s economic weakness to other eurozone countries or, more likely, to the world, via a bigger eurozone net export surplus.

According to the Organisation for Economic Co-operation and Development, the eurozone’s general government fiscal deficit will be close to 7 per cent of gross domestic product this year. Assume that this is to be cut swiftly to 3 per cent, while private sector financial surpluses remain close to 7 per cent of GDP, as is now implicitly forecast. Then the current account of the eurozone would need to improve by about 4 per cent of GDP. That would be about $600bn, or not far short of 1 per cent of world GDP.

Where does Germany think the offsetting shifts into greater external deficits might occur? This policy would surely make the post-crisis adjustment challenge for erstwhile deficit countries, including, not least, the US and UK, unworkable. Would an open world economy survive?

Maybe I am too pessimistic about the implications for demand of the envisaged fiscal tightening. Perhaps in some countries increasing the credibility of the fiscal position would stimulate private spending. Yet, overall, the eurozone would probably experience renewed demand weakness at home or export such weakness abroad.

Might an aggressive monetary policy make the difference? The ECB has been successful in sustaining rapid growth of narrow money during the crisis, more so, in fact, than the Federal Reserve and the Bank of England. But the growth of broad money has collapsed. Moreover, the aggressive monetary policy has failed to halt a sharp fall in nominal GDP, which shrank by 2 per cent in the year to the fourth quarter of 2009 inside the eurozone (see charts).

Unfortunately, monetary policy seems to be pushing on a string. It has made banks profitable and bankers richer, with modest benefit for the real economy. That is unlikely to change soon.

An alternative solution might be to help the world absorb larger export surpluses from the eurozone, the US, Japan and the UK. True, no sustainable exit from the present quagmire can be envisaged without increased net capital flows into emerging countries. It also seems evident that this is where the world’s surplus savings ought to end up. But it is going to take time and much reform to make this happen.

Let me make clear what I am saying and what I am not saying on the role of Germany in the eurozone and the eurozone in the world.

I am not saying Germany is at fault for making first-rate manufactured products. It is an admirable achievement. I am not saying Germany should make its workers uncompetitive or accept much higher inflation, either.

I am saying that Germany’s surpluses were made possible by other countries’ deficits, and so German stability by other countries' instability. I am saying that part of Germany’s net exports were illusory, paid for by excessive borrowing, often financed by Germans. I am saying that if peripheral Europe is to improve its external accounts, either Germany must offset some part of this, or the current account of the eurozone itself must shift towards surplus, with adverse impacts on the fragile world economy.

In short, economic policy is about more than competitiveness. When the world is trying to struggle out of a deep recession, demand matters, too. As the world’s fourth-largest economy and the core of the eurozone, Germany has a role to play in rebalancing global demand. I appreciate that this is a difficult challenge. It must be met, all the same.

BERLIN—Emergency aid for Greece should come from both the International Monetary Fund and bilateral negotiations with euro-zone partners, German Chancellor Angela Merkel said Thursday.

Ms. Merkel said in an address to Germany's lower house of parliament before leaving for a summit of European Union leaders in Brussels that she would make her case there that, "in an emergency, such aid must be awarded as a combination from the IMF and collective bilateral aid in the euro zone."

She also said that after the Greece's woes have abated, the 16 nations sharing the euro must pursue tough new measures and sanctions to prevent such crises in the future. "We've seen that the euro-zone's current instruments are inadequate," Ms. Merkel.

Ms. Merkel said she supported proposals by Finance Minister Wolfgang Schäuble, including a European Monetary Fund and the power to exclude profligate members from the common currency bloc—both drastic new measures that would require a lengthy ratification process and the approval of all 27 EU member states.

"I will also champion the necessary treaty changes," Ms. Merkel said.

Ms. Merkel said she hoped to work particularly closely with French leaders in designing a dual-track aid mechanism for Greece, and stressed that she didn't believe Greece's finances had deteriorated to the point where it needs such aid immediately.

Ms. Merkel's reluctance to finalize an aid package for Greece and the tough conditions laid out by her government this week on any future assistance have put her at odds with other powerful EU members such as France, where a decisive, EU-led effort was preferred.

"A good European isn't necessarily one who helps quickly," Merkel said Thursday. "A good European is one who respects European treaties and nations' rights, and helps in a way that the stability of the euro is not damaged."

Efforts to reach a common strategy for Greece will be at the center of an EU summit Thursday and Friday.

Jean-Claude Juncker, the head of the official group of finance ministers from the euro zone, said he expects aid for Greece to be a mix of loans from the International Monetary Fund and bilateral credits from individual euro-zone members.

Mr. Juncker is prime minister of Luxembourg, and also head of the Euro Group, which is the body that brings together finance ministers from the 16 countries that use the euro.

Mr. Juncker was speaking to reporters ahead of the EU summit in Brussels.

"I expect that the disagreement can be overcome," Juncker said. "My opinion is there will be a mix" between IMF and bilateral aid.

French officials are said to be trying to organize a meeting of leaders from euro-zone member states on the sidelines of the broader EU meeting, but it was still unclear Thursday morning whether that meeting would take place.

Greece is burdened by deep budget deficits and faces some €22 billion ($29.32 billion) on debt redemptions over the next two months. Its treasury also is paying interest rates more than three percentage points above Europe's benchmark borrower, Germany.

An aid package would be aimed at lowering those premiums by restoring investor confidence in Greek debt, allowing the government to refinace itself at lower cost.

Greek Prime Minister George Papandreou has asked euro-zone partner countries to give assurances that they would arrange standby credit facilities, declaring that asking for help from the IMF was another option.

"There is absolutely no reason that any rescue package must involve the IMF," a senior official in the Greek government said Thursday. "Most EU members, the [European Central Bank] and the [European] Commission agree that a solution must come from Europe alone."

Euro-zone finance ministers last week agreed that potential aid for Greece should be "bilateral" funding from other euro-zone countries.

IMF money wasn't mentioned, but in recent days Ms. Merkel has pushed for an IMF component of any aid package. The German public overwhelmingly opposes helping Greece, making aid a tricky political issue for Ms. Merkel at home.

China comments add to sovereign debt fears

By Jamie Chisholm, Global Markets Commentator.

Published: March 25 2010 08:54 | Last updated: March 25 2010 13:43

13:40 GMT: Growing concerns about sovereign debt found a significant mouthpiece on Thursday, when a senior Chinese central banker warned that the Greek crisis was just the beginning.

“We don’t see decisive actions telling the market we can solve this,” Zhu Min, a deputy governor of the People’s Bank of China, was reported as saying.

His comments caused the euro to dip to a new 10-month low versus the dollar, and encapsulated a nagging worry among investors that high levels of government indebtedness is one of the main risks facing the global economy.

However, the FTSE All-World equity index rose 0.6 per cent and some benchmark stock indices hit fresh cycle highs as investors chose to welcome news of a restructuring of Dubai World’s debt and some mildly encouraging US jobs data.

The euro later recovered some poise after the european central bank bent its collateral rules to help Greece, but the timing of Mr Zhu’s statement is particularly pertinent and suggests a fiscal focus will dominate markets for the short term.

Of immediate concern is the eurozone. A two-day summit of European leaders convenes on Thursday and investors need to hear that they have been able to knit together a safety net for Greece, lest it has trouble rolling over the €20bn of debt maturing over the next couple of months.

A downgrade of Portugal’s debt on Wednesday and the subsequent tumble in the euro should concentrate minds, but traders do not expect a clean and decisive outcome.

Indeed, Simon Derrick, chief currency strategist at Bank of New York Mellon, thought that Mr Zhu’s comments “might well signal the point that we stop talking about a “Greek debt crisis” and start talking about a “Eurozone structural crisis” instead”.

But there is a potentially more important issue emerging. The poor reception given to the auction of $42bn of US five-year notes on Wednesday points to fatigue among buyers of US government debt. If this continues, yields will rise, but not for the good reason – faster growth – but for the bad reason – too much supply. This could knock the nascent economic recovery and hit asset markets, particularly cycle-peak equities, hard.

And who buys most of the US debt? Why, Mr Zhu and his colleagues of course.

● US Treasuries continued to struggle following their pummelling on Wednesday. Yields on benchmark 10-year notes had jumped 15 basis points after the soft auction of five-years, but on Thursday a bit of “bargain hunting” quickly evaporated and yields rose another 1 basis point to 3.86 per cent. This kept yields above equivalent swap rates, signalling investors remain wary of government debt. The auction of $34bn of seven-year debt will be keenly watched later on Thursday.

UK government debt fell back as investors absorbed the implications for supply of the government’s Budget. The yield on the 10-year note rose 5 basis points to 4.01.

Greek debt was still unloved despite the ECB’s helpful move. The yield on 10-year bonds rose 7 basis point to 6.39 per cent, while the cost of insuring against default by Athens, as measured by credit default swaps, was little changed at 327 basis points.

Portuguese 10-year notes saw their yield rise 5 basis points to 4.38 per cent.

● The euro hit a new 10-month low of $1.3285 in Asian trading following Mr Zhu’s comments, but later rose 0.1 per cent to $1.3334. The dollar, which had bounced by more than 1 per cent on a trade-weighted basis on Wednesday, succumbed to some profit taking and was down 0.2 per cent to 81.84.

Sterling enjoyed a small bounce following better-than-forecast retail sales for February. The pound was up 0.2 per cent to $1.4904 and gained 0.1 per cent versus the euro to 89.42.

● US and European equity markets were blissfully unperturbed by the debt market troubles. In New York, the S&P 500 rose 0.7 per cent at the opening bell to a fresh 19-month high as traders hoped a slight improvement in initial jobless claims pointed to a strong non-farm payrolls number next week.

The FTSE Eurofirst 300 added 0.8 per cent and the FTSE 100 in London climbed 0.7 per cent to hit a new 22-month high above 5,700. A more stable euro and news of the restructuring of Dubai World’s debt appeared to help sentiment. The Dubai stock market jumped 4.3 per cent, but cynics noted a lack of detail in the Dubai World proposal.

● The FTSE Asia-Pacific index fell fractionally as bourses in the region noted the drop on Wall Street overnight. Shanghai lost 1.2 per cent and Hong Kong 1.1 per cent, though Tokyo managed to advance 0.1 per cent as the yen’s fall to a two-month low versus the dollar helped exporters.

● Gold was firmer after dropping sharply in the previous session to six-week lows as the dollar rallied. The precious metal rose 0.5 per cent to $1,092, but many traders thought it looked vulnerable to a fall through the bottom of its recent $1,080-$1,140 range.

IMF aid could push Greece out of eurozone

By Jane Foley

Published: March 24 2010 15:19 | Last updated: March 24 2010 15:19

The likely involvement of the International Monetary Fund in helping Greece to stabilise its fiscal position heightens the risk of the country leaving the eurozone, says Jane Foley, research director at

She says that for Greece, IMF involvement would mean it could attract funds at a cheaper price than on the open market. But for the European Union, it involves the indignity of admitting it does not have an adequate system to deal with fiscally errant members.

“One of the attractions of EMU membership for many countries was the ability to service debt at German-like yields. Greek yields are now substantially higher than those of Bunds – so Greece may be more likely to take the usual IMF course of devaluation.

“While Greece’s near-term funding needs may be nearer to being resolved, a wide-ranging set of uncertainties connected with the outlook for EMU are still in place,” Ms Foley says.

“The failure by key members to agree on how to deal with Greece highlights how inadequate EMU’s system of fiscal controls are. Furthermore, the decision by Fitch to cut Portugal’s sovereign credit rating highlights that Greece is not the only crack in the system.

“This is the lowest point for EMU since inception yet there is a tangible risk that the outlook for the system may deteriorate further and this should ensure the euro stays under pressure,” she says.

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