Dining on the Euro’s near death experience
15 Aug, 2011 10:05
Take a currency, one widely used as a reserve currency, including by Russia, and expose it to the blowtorch of market examination of its fundamentals. It isn’t pretty, and the Euro may be gone soon, if it the debt issue isn’t comprehensively addressed.
On the Menu – memories of fellow leaders pastTomorrow’s meeting between Angela Merkel and Nicholas Sarkozy will go a long way to determining the future of the Euro.The simple question on the menu is whether they can put together the politics to save the Euro.The politics isn’t easy.Almost every European leader from Papandreou in Greece, to the leaders in Ireland and Portugal who have introduced austerity, before heading to the electoral dustbin barely avoiding being tarred and feathered by their not so thankful electorates, and Spain where the election has been called, through to Berlusconi in Italy where the austerity is about to unfold, has shown where the politics is profoundly difficult.But the finances are equally so.After the bailout of Greece (twice) Ireland and Portugal the existing EFSF (European Financial Stability Facility), which was setup with a €440 billion – now needs to encompass the possibility of coming to the aid of Spain, Italy, almost certainly Cyprus (which seems to have gone under the radar, but has a banking sector far bigger than its size would indicate and is surprisingly closely tied to Russia) and maybe other – needs far more.Italy and Spain alone have an estimated €2.2 Trillion in outstanding debt compared to €630 billion for the nations which have already received bailouts.Settling past billsThe initial EFSF is built up through loans from existing Eurozone nations, plus a dollop from the IMF.The nations contributing to it included those receiving bailouts, with nearly 1/3 coming from nations which have either received bailouts, or like Italy and Spain, are in the firing line.That leaves any potential expansion in the hands of the larger or more solvent players, making France and Germany the twin pillars in terms of providing for its enlargement to €2 Trillion, with the need for their contributions to an enlarged EFSF already being factored in by markets, which explains in part some of the tremors in CDS swaps across the Eurozone in recent weeks.They are starting to question even the AAA rated nations of the Eurozone and the implications of what is potentially a massive additional debt servicing need by them, in order to ensure an adequate bailout for the whole Eurozone.To put that in context for theses nations it tends to represent an additional 14-20% of their standing debt, or generally adding about 8% of debt to GDP to their load.Then there are additional concerns with any and every potential bond purchase part of the EFSF, with questions over coupon values, durations, interest rates, and net present values, not to mention how they get accounted for by the nations receiving funds, and how the EFSF marks these to market.Dealing with haughty waitersThe other key factor in the malaise is the structure of the EFSF and its management.It currently revolves around sovereign debt issues if the Eurozone nations individually, and is managed by the ECB.The ECB has been buying bonds of the bailed out nations, plus those, belatedly, of Spain and Italy last week, while at the same time imposing a hard core dose of austerity every time upon the nations, as the price for stepping into the market.Arguments rage back and forth, but there is certainly a case for thinking that in some cases the austerity involved is not just making the life harder in these nations, but largely ensuring they will not see any real economic growth for some time, and as a result further eroding their capacity to service their existing debt.Against a backdrop of the ECB widely being seen as a key factor, through tightening rates too early and too far, in turning an nascent economic recovery into a near certain recession across much of the Eurozone, that is generating plenty of tension from aggrieved politicians having to tout austerity to those who vote for them at the behest of appointed officials.Silvio Berlusconi’s comments about ‘bleeding hearts’ and looking like an ‘occupied government,’ in the wake of getting the Italian parliament to agree to austerity measures on Friday encapsulates a mood which resonates strongly in Ireland, Greece, Portugal and Spain.Palatable and unpalatableThe meeting between Sarkozy and Merkel is expected to see the French leader push for the Eurozone to issue bonds backed by all 17 member nations. This would effectively entail the Eurozone developing the fiscal side critics have always maintained it lacks to go with its monetary side.Supporting the contention is the fact that the need to contribute to the EFSF and its enlargement is actually corroding market confidence in the stronger nations, as seen in the market treatment of French banks and French debt in the last week.That brings us back to another round of ugly politics.Germans aren’t terribly enthused about the prospect of bailing out their southern neighbours, and there is a constitutional challenge in Germany to the existing bailout. German resistance to any form of sharing responsibility for sovereign debts of other nations is profound, with Finance Minister Wolfgang Schäuble stating again on the weekend that "There is no collectivisation of debt or unlimited support."Germans are also aware that any thought of freeing the ECB from its need to ‘sterilize’ its bond purchases and head off to flood money markets while buying distressed Euro sovereign debt could be highly inflationary, and potentially destabilizing for a nation which has prided itself on rock solid finances – given that it would be required to provide most of the firepower enabling it to happen. The collection of centre right parties which comprise the majority in the Bundestag haven’t been backward in denouncing any hint of easing up for their European neighbours, giving Chancellor Merkel precious little political leeway. Dessert anyone?But writing in the Financial Times on August 14, George Soros sums up the vital role of Germany, and the need for Europe to be able to convince Germany to change its approach if the Eurozone is to survive.“Because the fate of Europe depends on Germany, and because eurobonds will put Germany’s credit standing at risk, any compromise must put Germany in the driver’s seat. Sadly, Germany has unsound ideas about macroeconomic policy, and it wants Europe to follow its example. But what works for Germany cannot work for the rest of Europe: no country can run a chronic trade surplus without others running deficits. Germany must agree to rules by which others can also abide.”The other side of the equation is that flooding the markets with money, would potentially generate growth in the Eurozone which would lighten the debt servicing issue for those currently looking at exporting people due to the lack of opportunities at home. Currently the ECB doesn’t have the scope for the scale of purchases needed, while ensuring these are sterilized.So that leaves the Eurozone wondering if Sarkozy and Merkel can come to agreement on allowing the ECB to proceed with unsterilized debt purchases, agreeing to issue Eurobonds which would be heavily reliant on Germany, or if they can come up with a system or general idea which they can sell to politicians and publics across the EU that involves fiscal transfers, joint responsibility for existing debts, and will calm markets.For if they come out with nothing more than glib statements, or more of the same it is a recipe for Euro and market chaos. James BlakeRT Business Internet