Wednesday, January 04, 2012

The year with the euro

The euro drama continues in 2012. Next week, Angie and Nick are scheduled to meet to come up with language for the new EU-minus-Britain treaty that will give the EU/Germany veto power over the national budgets of signatories and institutionalize various Herbert Hooverish economic policies like annual limits on budget deficits and a mindless upper limit on debt-to-GDP. An EU summit at the end of January is supposed to formalize the treaty language. Angie expects the EU-minus-one countries to approve the new treaties by the end of March.

The first quarter will also be tight for Greece and Italy because both have substantial debt to roll over during that period. Interest rates on 10-year Italian bonds will be an important sign. Last week, they were running just under 7.00% interest, 7% being the level which it is currently assumed as a benchmark that Italy will be pushed into default if it persists.

This started as a banking crisis, which it still is. European banks are undercapitalized and insufficiently regulated. The IMF realized as early as the summer of 2009 that Greece was overborrowed and needed a writedown of its debt, i.e., a default on a portion of its bond debt.

But Germany and France didn't want to see that happen, because it was expected to trigger a chain of financial events - writedowns of assets, triggering of credit default swaps (CDS) - that could slow lending to businesses and even bring down some big banks. So they decided on a bankdoor bank bailout, by giving Greece money to meet its bond payments so that private banks wouldn't have to write down their Greek bond holdings. Meanwhile, the European Central Bank (ECB) and national central banks also started buying up some of the Greek bonds from the private banks, thus transferring some of the risk from the bank stockholders to the public.

Unfortunately, both Angela Merkel and Nicolas Sarkozy, as well as the ECB and the International Monetary Fund (IMF), were wedded to austerity economics. So they required Greece to adopt severe austerity measures during this depression. Which caused their economies to shrink, which made their ability to repay the bond debt look worse. Meanwhile, bond speculators started going after other eurozone countries that had not been overborrowed as Greece had been: Ireland, Portugal, Spain, eventually Italy.

And the "Merkozy" duo repeated the same pattern: backdoor bank bailouts, refusal to recognize the magnitude of the writedown Greece needs, austerity economics, shrinking economies, escalation of the sovereign debt crisis.

There's not much doubt about what's needed to put the euro on a solid footing: have the ECB act as buyer of last resort for sovereign debt; establish eurobonds that could be sold on the strength of the credit of the entire eurozone and used by individual countries; and, establish a fiscal and "transfer" union with common budget policies among the eurozone. Greece's debt would also still have to be written down, even more so than Angie and Nick agreed to do last October.

It's may be too late, even if there were the vision and competence and will to do so in Germany, France and Britain. The current proposal does create a partial fiscal union, but basically just gives Germany the ability to impose more suicidal austerity economics on other eurozone countries.

Prospects for survival of the euro and the European Union don't look good right now.

Patrick Donahue summarizes the current situation in Euro Leaders Aim to Buy Time to Save Currency Bloomberg 01/02/2012:

Some 157 billion euros ($203 billion) in debt will mature in the 17-member euro area in the first three months of 2012, according to UBS AG. By the end of that period, leaders have pledged to draft a stricter rulebook for controlling government spending. German Chancellor Angela Merkel and French President Nicolas Sarkozy will meet in Berlin Jan. 9 to work out details. ...

The latest crack in Europe’s crisis-fighting plans appeared on Dec. 30, when Spain’s new government said 2011’s budget deficit would reach 8 percent of output, 2 percent more than the previous government had projected and more than the 6.9 percent expected by economists surveyed by Bloomberg. Prime Minister Mariano Rajoy responded by unveiling a new package of spending cuts and tax increases.

Still, the key to the euro’s survival may lie with Italy, the group’s third-largest economy and the second most-indebted after Greece. The government in Rome must repay 53 billion euros in debt in the first quarter, about a third of the euro area’s total amount for the period, after Prime Minister Mario Monti passed an emergency budget package aimed at curtailing borrowing costs.

Italy’s 10-year yield ended 2011 near the 7 percent mark that led Greece, Ireland and Portugal to seek bailouts. Spain’s equivalent yield finished the year just above 5 percent. Italian 10-year yields dropped 13 basis points to 6.97 percent today, while Spanish yields were little changed at 5.10 percent.
Tags: , ,

No comments: