NEWS,06.10.2012

Saving the Euro and the EU: Can Europe Do It?

 

With the continuous outpouring of bleak economic data from the EU, many are expressing deep pessimism bordering on despair about the prospects for the sustainability of the monetary union. Yet in some areas at least, progress is in evidence. Compared to the reluctance of the Obama administration to address the deeper causes of the American (and mutatis mutandis) global crisis, at least some structural causes of the EU crisis have been identified. Contrary to the not-always-well-informed American press, which seems congenitally pessimistic regarding the future of EU, actions are being taken by the EU to address some of these deep problems. On September 12, 2012, a German constitutional court took a momentous decision and prepared the way for the country's participation in a new European bailout fund. So far, markets seem to have reacted positively, though it is too early to be certain. Significantly, the pro-EU party in the Netherlands has won the elections recently also. This is encouraging. Furthermore, earlier the European Central bank (ECB) had reversed an earlier policy stance and decided that it would serve as a lender of last resort for government bonds after all.The deep underlying causes of the Eurozone crisis are the flaws in the design of the transnational monetary union. The Economic and Monetary Union(EMU) launched in 1999 consisted of the euro and the European Central Bank (ECB) for a common monetary policy. While the countries surrendered their ability to formulate and implement independent monetary policies, the fiscal and other economic disparities were not addressed. Nor was there a fiscal union, or even strong fiscal federalism and other institutional mechanisms required for coordinating structural policies to address the uneven economic development in Europe. Both the Werner Report of the 1970s and the Delors' Report of the 1980s, which served as the blueprint, had developed a three-stage roadmap comprising closer economic coordination among members, binding constraints on member states' national budget, and a single currency. The Maastricht treaty reflected these. But Krugman's inept joke at the time about the unpronounceable by the provincial American tongue at least name of the city indicating future trouble, did contain the germs of an apt economic argument and judgment. But that argument, not fleshed out by Krugman then, was far from the complacent conventional wisdom in Euro-American academe.In hindsight it seems clear that in their eagerness to put through a full and irrevocable European unity, the treaty makers had hastily concluded that the two convergence criteria written into the Maastricht Treaty a 3 percent limit on annual fiscal deficit and 60 percent limit on gross public debt to GDP ratio would be adequate for maintaining the irrevocable European unity. In truth, this was the result of using a flawed theory monetarist in its origin and naïve in terms of political economy and politics during possible crisis. In fact, no possibility of a crisis was countenanced.On the positive side, the institutional flaws have now been identified honestly and are being fixed. A key shortcoming in the design of the EMU was the absence of the lender of last resort in government bond markets. It is axiomatic that when a country issues sovereign bonds in its own currency there is an implicit guarantee from the central bank that cash will always be available to pay out the bondholders. One can call it an "implicit contract," following the insights of contract theory, a branch of theoretical economics developed vigorously in the last twenty-five years in North America and Europe. The absence of such an implicit contract in a monetary union where bonds are issued in a currency over which individual countries have little or no control makes the sovereign bond markets prone to liquidity crisis and contagion,very much like banking systems in the absence of lender of last resorts. Just as in the previous paragraph, the outcome was both the inability to use good theories that were in fact available and to use good long-term statesmanlike political judgment.The situation was compounded by the lack of flexibility of ECB earlier. For a long time, the ECB interpreted the no-bailout clause in the EU treaty quite rigidly. The "Central Bank" was reluctant to pursue the role of lender of last resort. As a makeshift structure, the policy makers set up the European Financial Stability Facility (EFSF) as a substitute. Recognizing that EFSF was not a good substitute took some time. But finally, it looks like that a permanent 500 billion euro European Stability Mechanism (ESM) may be established by the end of 2012 or in 2013. This week's German constitutional court approval was an important milestone for this process. It should have been clear, as some observers had noted that the EFSF will run out of money. Thepresent writer made this point in several UN and other symposia from the beginning of the crisis. Others have also made the same point recently. Having bailed out Greece, Ireland, and Portugal, the EFSF is running out of steam. It is also due to expire in less than a year. Therefore, the establishment of ESM is or should be a critical item on "saving the EU" agenda.Furthermore, it should be noted that there has been a dramatic turnaround in the ECB and that is something new and important. In July, ECB chief Mario Draghi, had promised to "do whatever it takes" to protect the euro. On September 6, he announced plans to make the ECB the lender of last resort in government bond markets. Under the new program called the Outright MonetaryTransactions (OMT), the ECB will buy existing government bonds in the secondary market without limits. The OMT will primarily benefit fiscally troubled countries like Spain and Italy which are facing difficulties financing their debt as their borrowing costs have soared in recent months. The arrangement should have come much earlier. But it could be a lifesaver for EU now. There are still issues of fiscal austerity and related to this is the crucial question: which class will bear the burden of adjustment? Internal class struggles could derail the whole effort that is underway now. It remains to be seen ultimately how technically astute and politically wise the ruling elites in the most powerful EU countries are. The fiscal compact and banking union are both steps in the right direction. Ultimately, only a more deeply democratic union based on fair class compromises can save the EU.

 

Why Iran Won't Cave on Nuclear Enrichment

The plunge of the rial, Iran's currency, has been breathtaking. In 2010, it traded for about 10,000 for one U.S. dollar. Now, the Iranian government, its dollar earnings halved by the economic sanctions the United States and its allies imposed (supplementing those adopted in the United Nations) to end its uranium enrichment program, is rationing dollars, selling them for about 12,264 to the dollar, and for essential imports only. Iranians, panicked by the plummeting of their currency, have turned to the bustling black market. But they have to pay a steep price for the trade: this week, about 39,000 rials for a dollar. The government could try to put black marketers out of business, but to do that it would have to close the gap between the official rate and the black market price, in favor of the latter. Not a good choice. The currency crisis has created big problems for ordinary Iranians. It's not just that the dollars they need when they go abroad are hard to get (not many of them can afford such outings in any event); it's that the price of any item made, in whole or part, with imported materials costs a whole lot more now. For the business and commercial class, a politically important segment of the population, the rial's plight means shrinking profits.So that's the economic side of things. But it's the political angle that's getting the most attention in the United States. That's because the goal of the sanctions is to pressure Iran to dismantle its enrichment program so that the Obama administration can avoid resorting to a military strike, which it has insisted remains an option. Quite apart from the question of whether it would destroy Iran's enrichment installations (especially the underground complex at Fordow), bombing Iran risks setting off a chain of dangerous events in a part of the world that's already violent or unstable. The urgency of finding a non-violent way to change Iran's mind on enrichment stems in large part from the administration's fear that Israel might give up on the diplomacy-plus-sanctions approach and attack Iran's nuclear installations unilaterally, a move that would unavoidably draw the United States into the fray. Given this context, the question being debated in newspapers and on the airwaves now is this: Does the rial's precipitous fall prove that sanctions have hurt Iran's economy to the point that Tehran is now willing to talk about dismantling its enrichment program? The other political element of the currency drama is what Wednesday's street protests in Tehran, generated by public anger over the rial's loss of value and economic dissatisfaction more generally, mean. The question raised by the demonstrations is this: Are we witnessing the beginning of an Arab-Spring-like revolution in Persian Iran that will convince the leadership to shift its position on nuclear enrichment?The answers to both question is "No." Why? No matter how hard the sanctions have hit Iran, Tehran doubtless understands that it would communicate its weakness and panic by shifting its position on enrichment now. It no doubt anticipates that the United States in particular will stick even more doggedly to its position, which is that sanctions will be lifted only once there's verifiable evidence that enrichment has been terminated. By contrast, Iran has proposed a series of steps, the last of which would be putting activity at the Fordow facility on hold. But it wants sanctions to be eased at the outset and to be lifted fully before it moves on Fordow. The two positions Tehran's presented formally, Washington's evident from the Obama administration's myriad statements are diametrically opposed. Tehran will doubtless assume that moving toward the U.S. position amidst a currency crisis accompanied by internal unrest will surely encourage calls for more concessions because the Obama administration will conclude that Iran's leadership is desperate. It doesn't take a genius to understand that it's a bad idea to enter a bargaining process when the other side thinks it has you on the run. And the Iranian leadership knows a thing or two about bargaining.Quite apart from Tehran's reluctance to come to the table with an even weaker hand than it's been holding, there's the problem of achieving consensus among the various institutions and political groups that have a say on the nuclear program. Achieving harmony will be even harder when the heat is on because the advocates of compromise risk being tagged by hardliners as sellouts. It's not a simple matter of Supreme Leader Ayatollah Ali Khamenei snapping his fingers (even assuming that he would do so) to break a deadlock.What about the effect of Wednesday's demonstrations? Here there are three things to keep in mind. First, it's unclear whether they betoken the beginning of bigger protests that could shake the regime's roots. Maybe yes, maybe no, but the Iranian leadership is not going to change course on uranium enrichment just because of what occurred on the streets this week. Second, even if more protests erupt, the government will use intimidation and force as its first line of defense; and it has plenty of resources with which to instill fear and use violence. Third, hawks with the leadership will argue that concessions on enrichment at a time of internal instability will embolden not just the United States, but worse, the protesters as well.Paradoxically, there's a way in which the rial's nosedive and the public protests ease the pressure on Tehran. President Obama's case that sanctions are working and should be given more time is stronger now, and Israeli Prime Minister Binyamin Netanyahu's refrain that they are not and that it's time to consider a military attack is weaker.The bottom line? Don't expect big changes in Iran's position on nuclear enrichment anytime soon. 

Netanyahu Aligns With Obama on Iran

While most media attention focused on the cartoon bomb presented by Israeli Prime Minister Benjamin Netanyahu during his speech at the United Nations General Assembly, something even more newsworthy passed almost without notice: Netanyahu made it clear that he has endorsed U.S. President Barack Obama's policy on Iran. By literally drawing a red line to show how far he could tolerate Iran's nuclear program, Netanyahu in effect approved of the international efforts led by the Obama administration to prevent Iran from acquiring a nuclear weapon. In fact, while he would never admit it in the midst of a campaign, even Mitt Romney picked up on this view and has, in practice, endorsed Obama's approach. That sudden outbreak of unspoken consensus is the real story of the last week of diplomacy. The real question now is, what can be done with the broad agreement that there is both time and space for a diplomatic solution to the crisis over Iran's nuclear program that has created a new window of opportunity? And that depends on two big wildcards: what Netanyahu's red lines really are, and Iran's real intentions and capabilities.In Netanyahu's speech, he made it clear that Israel has a red line for the Iranian nuclear program. While this red line for military action has evolved over the years, it now appears to be the point at which Iran has enough low enriched uranium at nearly 20 percent enrichment levels to potentially produce one nuclear bomb. In Netanyahu's estimation, that time won't come until sometime next year, perhaps in the spring or even the summer. If Iran were to achieve that level, it would be threatening enough for Israel to justify striking Iran, according to Netanyahu. The prime minister identified this as his red line because it would be the furthest point at which Israel could feasibly attack Iran's nuclear enrichment facilities.As the prime minister said:"The relevant question is not when Iran will get the bomb. The relevant question is at what stage can we no longer stop Iran from getting the bomb. The red line must be drawn on Iran's nuclear enrichment program because these enrichment facilities are the only nuclear installations that we can definitely see and credibly target."Israel, according to nearly three-dozen bipartisan national security leaders who signed onto a report by the Iran Project, doesn't have the capacity to conclusively destroy Iran's nuclear program. However, it does have the capacity to delay it through bombing enrichment facilities. But that would be a disaster, as it would likely unravel the international pressure on Iran to come clean, unleash a devastating war in the region, fuel antagonism toward the United States and fail to permanently end the international community's concerns about Iran's nuclear ambitions.Yet if past is prologue, Israel tends to strike its adversaries' nuclear facilities when it feels vulnerable, not when the international community deems it wise. Israel struck the nuclear facilities at Osirak in Iraq in 1981 and Syria in 2007 but only made limited strikes. In the case of Iraq, the attack drove the program underground and accelerated its push for nuclear weapons an outcome that Israel would not want today in Iran.In this case, by appearing to set a red line Netanyahu actually gave a boost to the role of serious U.S. diplomacy to resolve this issue. This is because of what Netanyahu didn't say in his speech: that any Iranian nuclear program is unacceptable. This little-noticed absence gives a crucial boost to the prospects for a nuclear deal. He only said that Iran should not be allowed to enrich enough uranium to have the makings of a bomb. By implication, this means that with strict safeguards, commitments to cap enrichment levels, and export or conversion of uranium for reactor fuel plates Israel could live with an Iranian nuclear program. This is where the international negotiations, led by the Obama administration, have been heading. And now Netanyahu has publicly signed off on this approach.Of course, Iran has a role to play, and could continue to keep Israel and the international community on the edge of their seats by proceeding to raise and lower the levels of its stockpile as it sees fit. This is because it takes roughly 225 kg of nearly 20 percent enriched uranium to make one bomb's worth of fissile material although that material would still need to be purified up to 90 percent levels. It's important to remember that, according to the latest International Atomic Energy Agency (IAEA) report, Iran recently reduced its stockpile of 20 percent uranium to less than half of that red line, from 101 kg to 91 kg, by converting a portion of the stockpile into fuel plates for use at the Tehran Research Reactor.But there are severe downsides for Iran to continue to play such games, as the devastating sanctions currently in place will remain. Iran, which needs to get out from under international pressure and isolation, should seize the opportunity to credibly deal at the negotiating table with the United States and its international partners. There is no guarantee that it will do so, but the time will soon come when it must show its cards.Now that the speeches are over and the threat of immediate war has receded, the real work of diplomacy must step in to resolve this dispute. It's clear from Netanyahu's speech last week that a diplomatic deal that allows for some type of Iranian nuclear program is in the cards. It's also clear that Israel depends on the sanctions that the Obama administration has orchestrated, on the information gathered by IAEA inspectors about Iran's nuclear program and on the multilateral negotiations underway.So all eyes are on Washington to guide the diplomacy to resolve this sticky situation without a war. Backing up the support for diplomacy is the fact that the American people oppose getting involved in another war of choice in the Middle East. Nevertheless, the United States and Israel may still decide that they, in fact, have no choice. Yet one thing is certain from last week: U.S. leadership in the Middle East is neither diminished nor irrelevant. If anything, it is clear that it is working, and that it will be counted-on even more in the days to come.