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And, while lower investment since the beginning of the crisis has led to a smaller capital stock, again the effect appears quantitatively small. It is also difficult to see why the crisis would have led to a large decrease in total factor productivity. This being said, I would have expected a large output gap to lead to more downward pressure on inflation than we have seen. I see the fact that inflation is roughly stable is a puzzle. We are doing more research on this issue at the IMF.

O.B.:There is no question internal devaluations are tougher to achieve than when you can adjust the nominal exchange rate. That’s well understood. A number of European countries have a competitiveness problem, which shows up in a large current account deficit.

olve it. And there is no alternative for them than to become more competitive, to decrease the real exchange rate. Is it happening? I think it’s starting to happen, but it’s happening slowly, and it’s going to take a long time.

The recently created European Banking Authority has only limited powers over national supervisors, whose daily work is guided mainly by national considerations.

Moreover, the ECB already bears de facto responsibility for the stability of the eurozone’s banking system. But, until now, it had to lend massive amounts to banks without being able to judge their soundness, because all of that information was in the hands of national authorities who guarded it jealously and typically denied problems until it was too late.

Consider the case of a bank headquartered in Italy, but with an important subsidiary in Germany. The German operations naturally generate a surplus of funds (given that savings in Germany far exceed investment on average). The parent bank would like to use these funds to reinforce the group’s liquidity. But the German supervisory authorities consider Italy at risk and thus oppose any transfer of funds there.CommentsView/Create comment on this paragraphThe supervisor of the home country (Italy) has the opposite interest. It would like to see the “internal capital market” operate as much as possible. Here, too, it makes sense to have the ECB in charge as a neutral arbiter with respect to these opposing interests.

No, of course not. Today, we live in a currency zone that, despite everything, is significantly more stable than where the dollar or yen are used. The euro has brought growth and prosperity to Europe.

Actually, the euro was a mistake with particularly serious consequences. A monetary union requires its members to pursue the same policies and be similarly productive. The so-called convergence criteria were meant to ensure that this would happen. But -- as the dramatic developments in Greece are now showing -- they didn't.

Unfortunately, our fears have become a reality. The monetary union was launched with real self-deception.

You should look at it more holistically. We wouldn't have been able to increase our exports if the other countries had behaved like us and had not increased their demand for an entire decade.

Excluding Greece from the union would be the completely wrong approach. Greece's problem is its inefficiency in terms of public finances. That can be corrected.

Starbatty: In my experience, speculators are only successful when political promises diverge from economic reality, as has become clear in Greece.

Its full name is more than a mouthful. Trans-European Automated Real-time Gross Settlement System is better known as TARGET2 for short. It is the behind-the-scene payments system that conveniently enables citizens across the euro area to settle electronic transactions in euro. And at just over €500 billion, its TARGET2 claim on the Eurosystem is also the largest and fastest growing item on the Bundesbank’s balance sheet, as well as a source of much misunderstanding and debate.

The allocation of TARGET2 balances among the seventeen national central banks, which together with the ECB make up the Eurosystem, reflects where the market allocates the money created by the ECB. The fact that the Bundesbank has a large TARGET2 claim (asset) on the Eurosystem, while national central banks in southern Europe and Ireland together have an equally large TARGET2 liability, simply reflects that a lot of the ECB’s newly created money has ended up in Germany. Why? Because of capital flight.

Since the euro eliminated exchange rate risk among its member states, Germany has invested a substantial portion of its savings in Europe’s current account deficit countries. Some of those savings are now returning home. That’s the capital flight.

Lenders in Germany, France and the U.K. had $1.19 trillion of claims on those four nations at the end of 2011, Bank for International Settlements data show.

Lenders in Germany and France saw an increase in deposits of 217.4 billion euros, or 6.3 percent, in the same period.

To prevent contagion, countries in the euro area would have to form a full-fledged political and fiscal union immediately and implement uniform guarantees on bank deposits throughout the region, Thomas Wacker and Juerg de Spindler, economists at Zurich-based UBS, said in a separate note. They said such a response can be ruled out.

While countries like Greece and Spain often face criticism for a lack of prudence that got them into trouble and caused the eurozone crisis, French and German banks were the enablers. During the boom years before 2008 they made huge loans to countries in Southern Europe, and today many banks remain vulnerable to the problems of those countries.

German banks are less exposed to Greece but are owed 134 billion euros by Italian borrowers and 146 billion euros by Spanish customers.

Private and public borrowers in Spain still owed 115 billion euros to French banks at the end of 2011, according to the Bank for International Settlements. Italian borrowers owed 332 billion euros to French banks, and Greek borrowers owed an additional 44 billion euros.

German exporters were major beneficiaries of this growth. German banks and financial institutions helped finance the growth.

Exports have provided the majority of Germany’s growth in recent years. Germany is heavily reliant on a narrowly based industrial sector, focused on investment goods—automobiles, industrial machinery, chemicals, electronics and medical devices. These sectors make up a quarter of its GDP and the bulk of exports.

Germany’s service sector is weak with lower productivity than comparable countries. While it argues that Greece should deregulate professions, many professions in Germany remain highly regulated. Trades and professions are regulated by complex technical rules and standards rooted in the medieval guild systems. Foreign entrants frequently find these rules difficult and expensive to navigate.

Mr. Weber, who is also a member of the European Central Bank’s governing council, said that the statistics reflected Ireland’s status as a financial center: much of what is recorded as claims on Ireland is in fact money funneled through Irish subsidiaries of German banks, and ultimately bound for elsewhere, Mr. Weber said. He said total German exposure was closer to $30 billion.

In both cases more than half of the exposure was to Ireland’s private sector, rather than lending to the government or Ireland’s beleaguered banks.

In Germany, Hypo Real Estate, a property and public sector lender owned by the government after a bailout, owed its near collapse largely to problems at Depfa, its subsidiary in Dublin. Last month Hypo transferred most of its troubled assets to a so-called bad bank that will slowly wind down the investments.

German and French banks call the shots Print Email  NormalLargeExtra Large ShareNew  0  0   Also in European Debt crisis: European shares edge lower and growth worries persist Bank of England's Tucker 'wasn't encouraged to lean on Barclays' Draghi keeps door open to further interest rate cuts Marks and Spencers sales hit by summer deluge Spain's debt tops 7pc danger level as Madrid gets more time European Home "Shocking" 2012 HoroscopeWhat Does 2012 Have In Store For You? Shockingly Accurate. See Free!www.PremiumAstrology.comExpat Health InsuranceQuick, Compare, Trusted Website Expatriate Health Insurance Quoteswww.ExpatFinder.com/Instant-Quoteshttp://www.googleadservices.com/pagead/aclk?sa=L&ai=BMEejVeb8T8fDKoSG_QaAhrTCB-q_1OYBmoqphxvAjbcB0NkREAMYAyDgw6kIKAU4AFD4gumFAmCpsL6AzAGgAairsfEDsgESd3d3LmluZGVwZW5kZW50LmllyAEB2gFfaHR0cDovL3d3dy5pbmRlcGVuZGVudC5pZS9idXNpbmVzcy9ldXJvcGVhbi9nZX

d, for reasons best

known to itself, the ECB -- in clear contravention of both previous market precedent and financial logic -- has insisted that the senior bondholders be repaid in full and has lent the Irish banks, institutions which it must have known were hopelessly insolvent, €70bn to do so.

However, Irish companies and banks are very highly indebted to foreign banks -- three times more than the Greeks.

According to Germany's central bank, the Bundesbank, German banks are Ireland's biggest creditors, to the tune of €166 billion ($226 billion), and that includes hundreds of short-term loans to Irish banks. How dangerous is the Irish crisis for Germany?

The situation is very dangerous. The German government has a vital interest in ensuring the solvency of the Irish state and its banks.

The immediate consequences of Greece leaving or being forced out of the euro area would certainly be devastating. Capital flight would intensify, fuelling depreciation and inflation. All existing contracts would need to be redenominated and renegotiated, creating financial chaos. Perhaps most politically devastating, fiscal austerity might actually need to intensify, since Greece still runs a primary deficit, which it would have to correct if EU and International Monetary Fund financing vanished.

But this process would also produce a substantially depreciated exchange rate (50 drachmas to the euro, anyone?) And that would set in motion a process of adjustment that would soon reorient the economy and put it on a path of sustainable growth. In fact, Greek growth would probably surge, possibly for a prolonged period, if it adopted sensible policies to rapidly restore and sustain macroeconomic stability.

Just look at what happened to the countries that defaulted and devalued during the financial crises of the 1990s. They all initially suffered severe contractions. But the recessions lasted only one or two years. Then came the rebound. South Korea posted nine years of growth averaging nearly 6 percent. Indonesia, which experienced a wave of defaults that toppled nearly every bank in the entire system, registered growth above 5 percent for a similar period; Argentina close to 8 percent; and Russia above 7 percent. The historical record shows clearly that there is life after financial crises.

But the shortcomings of the agreement have once again undermined renewed confidence in the eurozone and sent the bond yields of several countries higher, including Spain and Italy.

The Spanish government said a predicted rise in GDP next year of 0.4% had proved optimistic, and the economy would suffer another year of recession.

Regional governments deliver the key parts of the welfare state, including health, education and social services.

The decision by the International Swaps and Derivatives Association ends months of speculation that a Greek default might not set off the swaps, a result that could have undermined their role as insurance against debt defaults.

Still, doubts about the instruments’ effectiveness may linger. European officials initially shaped the Greek debt restructuring to avoid activating them. The concern is that future restructurings could be arranged to stop swaps from paying out.

the restructuring activated the swaps only after the country made a legal move on Friday.

French loans to Spanish banks plunged 34 percent in the fourth quarter of 2011 compared with the previous quarter, according to the latest data from the Bank for International Settlements.

For Italian banks, French bankers cut their exposure by 16 percent. German banks have also been increasingly wary of their Italian and Spanish peers, reducing lending to them by about 19 percent last year

Ms. Lagarde's empathy is wearing thin and this is unfortunate—particularly as the Greek failure mostly demonstrates how wrong a single currency is for Europe.

During the next stage of the crisis, Europe's electorate will be rudely awakened to the large financial risks which have been foisted upon them in failed attempts to keep the single currency alive. When Greece quits the euro, its government will default on approximately 121 billion euros of debt to official creditors and about 27 billion euros owed to the IMF.

Investors Seek Yields in Europe, but Analysts Warn of Risk

Once again, foreign investors are piling into the government bonds of Ireland, Spain and Portugal — countries that got into such debt trouble that they required bailouts. Now these countries are able to sell their bonds at lower interest rates than they have seen in years, renewing hope that Europe has turned a corner.

Claus Vistesen, the head of research at Variant Perception, a London-based economic research group, sees the ratio of debt to economic output as a continuing threat to a euro zone recovery.“People think growth is coming back,” Mr. Vistesen said, “but at the end of the day, debt is still going up.”

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