Brussels throws gauntlet down to Berlin
The European Commission leapt off the fence yesterday proposing many of the policies – a bank deposit guarantee fund, longer for Spain to make the cuts demanded of it and allowing the euro zone rescue fund to lend to banks direct (though there were some mixed messages on that) – that would buy a considerable period of time to move towards its ultimate goal: the sort of fiscal union that would make the euro zone a credible bloc much harder for the markets to attack.
The proposals would go a long way to removing Spain from the firing line, and suggests Brussels at least has decided it now urgently needs to shore the country up. But Germany opposition to all three still appears to be steadfast.
Time to dust off the golden rule of this crisis – dramatic decisions are taken only when the bloc is staring right into the abyss. We’re not quite there yet, though not far off, so there has to be a chance of something seismic resulting from the end-June EU summit which follows June 17 Greek elections. The leaders of Germany, France, Italy and Spain meet in between, just after a G20 summit which will presumably press Angela Merkel hard too. As European Commission President Barroso said yesterday, speed and flexibility will be of the essence although at least some of what is being discussed would require time-consuming treaty change.
There’s absolutely no guarantee that Germany’s Merkel will bend but, as at the G8 summit earlier this month, she will cut a fairly lonely figure if she does not. Merkel, Italy’s Mario Monti and France’s Francois Hollande talked to President Obama last night with Washington’s pressure for more decisive action presumably restated. Obama has despatched one of his top Treasury officials to European capitals this week to deliver the same message.
Pressure is also coming from the ECB, which is calling for euro zone deposit guarantees and a bank resolution mechanism while remaining very cool to Spanish calls to revive its bond-buying programme. ECB chief Draghi has told the European Parliament this morning that a credible mechanism for recapitalising euro zone banks and improving oversight is needed urgently.
Greek polls basically show the election is too tight to call with a real chance that the anti-bailout SYRIZA could prevail. The Irish, who vote in a referendum today on the bloc’s fiscal treaty, look less of a threat to the euro zone with polls pointing firmly to a ‘yes’ vote. The reverse would set off another round of jitters though the damage would be greater to Ireland itself as only 12 of the 17 euro zone nations are required to rafity the act to bring it into force. A ‘no’ would push Ireland to the margins and threaten its access to future bailout funds. Results will not be known until Friday.
Not for the faint-hearted
With Spain’s banking system looking ever more parlous and the Damoclean Sword of Greek elections hanging over the financial markets, next week is not going to be for the faint-hearted.
Stock markets have endured another volatile week, rising early on before falling sharply just before the EU summit, then rising the day after – all this when very little changed on the euro zone landscape. Increasingly, the downward moves are sharper than the upward ones and there is little prospect of things settling before the June 17 Greek elections. It seems everyone is so nervous that if they are sitting on a day of gains, they cash them in double-quick.
Page one of the crisis management manual says get all the bad news out quickly. The handling of troubled Spanish lender Bankia has been an abject failure in that respect. First, the government said it would require about 9 billion euros to shore up, a few days on they are looking at 20 billion. One proposal doing the rounds is to create one nationalized bank out of a number of failed lenders. The big question, to borrow heavily from Louis XV, is: Apres Bankia la deluge?
It looks increasingly likely that Madrid will have to take a bailout for its banking system despite its protestations to the contrary. The money is there in euro zone rescue funds to cope but one of Spain’s only trump cards – that it had issued well over half the debt it needs to this year – may have disappeared after the government revealed that the publicly stated figure for the autonomous regions’ maturing debt – 8 billion euros for this year — is in fact more like 36 billion.
If Spain looked in real trouble (Greek contagion could play a part here) that might be the tipping point that persuades the euro zone to take more dramatic action. With German opposition to common euro zone bonds unbudgeable for now, a lot of the onus would fall on the ECB which, while deeply reticent to revive its bond-buying programme, could well be pushed into a third round of three-year money creation at some point. And if there was any sign of a bank run, plans for a deposit guarantee fund could have to be dusted off very quickly. Would that do the trick?
If Spain can be dealt with via existing bailout funds – if it comes to that – it may well be that, as it was last year, it would take Italy to come seriously into the firing line to push the ECB into overdrive. Italy will sell debt of varying denominations on Monday, Tuesday and Wednesday, giving plenty of scope for jitters. And there’s plenty else besides to keep longer-term investors on the sidelines.
Ireland holds its referendum on the new EU fiscal treaty on Thursday with the result expected the day after. Polls suggest it will pass. If it didn’t, the country would have a serious headache given it is under a bailout programme but would have rejected the debt rules the bloc is being asked to meet. While the treaty needs the approval of only 12 of the 17 euro zone countries to be ratified, an Irish rejection would be another scab for markets to pick away at.
Risk of contagion if Greece exits euro: WestLB
What happens if Greece leaves the euro? No one can say for sure. But John Davies at WestLB, finds it difficult to envision a benign outcome.
Greece’s economy, at around $300 billion, is very small compared to the euro zone as a whole. The problem is if other countries follow suit – or are pressured in that direction by stubborn financial markets.
Such a scenario doesn’t bear thinking about because it is so horrible.
There is a good chance that the market would immediately trade Portugal towards pre-debt swap Greece levels. The next in line would certainly be Ireland and Spain.
Initially you have got to assume that spreads would become even more dislocated. As you are moving out and down the credit curve the ones with the weakest credit ratings will likely suffer worst, at least initially, because we are moving clearly into the world of the unknown and that’s precisely what the market doesn’t like.
The Greek elections have left a political vacuum that is raising speculation that the country may eventually exit the euro. Last Sunday, Greek voters punished mainstream parties that supported harsh austerity in exchange for international bailout cash. That left the Greek parliament with a jumble of minority parties that have been unable to form a government.
The leaders of Greece’s once-dominant conservative and socialist parties made a push on Friday to avert new elections and prevent a victory by a radical leftist who has promised to tear up its international bailout deal.
Inability to implement the reforms set out by international lenders amid this political void could compromise the country’s life-support bailout money and lead to a default. This could make the country’s membership of the euro increasingly unsustainable, even though those very reforms risked choking growth further in an economy suffering its fifth year of recession.
Even Germany, the key driver of growth in the euro zone, might eventually be threatened by worsening financial and economic conditions around it. And what of the bullish German Bund market which seems to know no bounds? Davies again:
debt relief by more debt added faster…faster..faster.faster…
the math is compelling.
the greeks must default…default..default.default…
printing is the world’s only current option. if, and only if, the major currencies agree to unified manipulation of currencies, and stick to it, can the pain inflicted by fiat foolishness be gentled enough to allow the real people to be ok.
p.s. the printers must agree to a fixed ‘flow’, but that’s another story.
Never mind the pain, feel the austerity
Austerity in the euro zone seems to be working — at least as far as the headline, dry, soulless numbers of budget balancing are concerned. Bailed out Greece and Ireland have reported substantial improvements in last year’s profligacy performance. Spain, while going in the wrong direction, at least has the satisfaction of being told it is not telling fibs.
We will get to the smoke and mirrors in a bit.
First Greece, the euro zone’s poster child for budget ill-discipline. The 2011 budget deficit to GDP ratio – basically the annual overspend — came in at 9.1 percent. This may seem like a lot given the EU target is 3 percent, but it was down from 10.3 percent a year earlier and from 15.6 percent the year before that. Furthermore, if you take out all the debt repayments costs that Athens has to make , you end up with only 2.4 percent (although in truth that is like pretending you don’t have a mortgage).
In Ireland, the craic was all about trouncing expectations. The deficit to GDP ratio for 2011 came in at 9.4 percent, which compared with an original 10.6 percent target and even a revised target just last December of 10. 1 percent. Everything is on track, Dublin reckons, to meet this year’s 8.6 percent.
Now, those not wanting their party pooped, please look away.
The official figures suggest that Greece’s improvement is almost entirely down to increased revenues. Government spending as a percentage of GDP last year was 50.1 percent, barely changed from a year early and only a tad down from 2008. And this comes after a number of years of painful austerity that has helped keep Greece in recession for more than four years — it is into its fifth now, staring at a 4.8 percent 2012 contraction — and that has pushed more than a fifth of the country out of work. Greece’s debt (ie accumulated deficits) as a proportion of GDP last year was 42.3 percentage points higher than in 2008.
Ireland, in the meantime, was enjoying its deficit improvement (still the worst in the euro zone) by finessing away one-off capitalisations into its banks that were worth some 3.7 percent of GDP. Including those and some others, the deficit last year was 13.1 percent. This comes after Ireland has made budgetary adjustments totalling 25.4 billion euros since 2008 — the equivalent to 16 percent of it 2011 GDP — and has had to hike taxes and cut spending by 8.6 billion euros between 2013 and 2015, i.e. another 5 percent of GDP. It is back in recession and seeing its exports hit by the troubles is main trading partners in the European Union are having.
Election fever hits the markets
We’re not talking about the U.S. presidential vote, though that does cast another layer of uncertainty over the outlook. Rather, investors are focused on even shorter-horizon events, as evidenced by this jam-packed electoral worry list from Marc Chandler, currency strategist at Brown Brothers Harriman:
This weekend’s first round of the French presidential election kicks of the quarter that will include:
* Greek national elections, where polls warn that the current coalition government may not be returned, increasing the uncertainty.
* Italian municipal elections which will be, at least in part, a referendum on Monti, who has seen his support wane since the labor reform was unveiled.
* Two German state elections, which may see the FDP further marginalized, making a grand coalition next year more likely.
* Irish referendum on the fiscal compact. Due to qualified majority procedures, an Irish rejection would not prevent the adoption of the fiscal compact, but would jeopardize Irish access to the ESM, should it be needed.
* After the second round of the French presidential election in early May, there is the parliamentary election in June.
Today in the euro zone – a blizzard of bailout numbers
Brace yourself for a blizzard of numbers.
EU finance ministers gathered in Copenhagen are poised to decide precisely how much firepower their new rescue fund – to be launched mid-year – will have. A draft communiqué suggests that as of mid-2013, presuming no new bailouts have been required in the interim, the combined lending ceiling of the future ESM and existing EFSF bailout funds will be set at 700 billion euros (500 billion pledged to the ESM plus the roughly 200 billion already committed to Greek, Irish and Portuguese rescue programmes).
Up to mid-2013, if 700 billion proves to be insufficient — i.e. someone else needs bailing out — euro zone leaders will be able to bolster it with the 240 billion euros as yet unused in the EFSF, according to the draft, although German Finance Minister Wolfgang Schaeuble said last night that 800 billion should be the absolute limit.
Sorry, there’s more. Because the ESM will not have its full 500 billion euros capacity on day one – it will build up over time – the real available figure for the next year is more like 640 billion euros. Confused? You should be.
Nonetheless, this is probably sellable by Angela Merkel to German MPs and her public as not being a real increase at all (which is not that far from the truth) while also probably being enough for Christine Lagarde to seek greater crisis-fighting funds for the IMF from its non-European members, most of whom have said they would provide nothing until the euro zone shows some serious intent of its own. The IMF spring meeting looms next month.
The big question is, is it enough to keep markets calm? The possibility of drawing on the extra 240 billion over the next year might do the trick but it’s not yet guaranteed that that will be agreed. If the ministers only offer up a 500 billion fund plus the money already committed to bailouts (which really is not new money at all), there could well be a wobble. The other big setpiece of the day is the Spanish budget, which Rajoy insists will be tough. Markets are watching closely. Spain reported a budget shortfall of 8.5 percent of GDP in 2011 and faces a target of 3 percent next year. It can ill-afford any slippage; its bond yields have already started rising since Prime Minister Mariano Rajoy rejected the first 2012 target agreed with the European Commission and secured a softer goal.
Rajoy has promised a tough budget which economists predict will push Spain into a pretty deep recession this year. The government believes 35 billion euros of cuts will allow it to meet its deficit targets but given an economic downturn will cut government revenues, some analysts estimate nearly double that amount will be needed. The outside pressure for reform is unrelenting. Schaeuble said a youth unemployment rate nearing 50 percent was little surprise considering the state of Spanish labour laws.
Ireland’s uneasy market comeback
Ireland, hailed as the poster child of euro zone austerity, is hoping to get back into the long-term bond market this year. But analysts say a hasty return could do more harm than good.
Its market position has certainly improved since it was pushed out of commercial markets and forced to seek a bailout, even though the population at large is still struggling with rigorous austerity.
Ten-year Irish yields have halved to just below 7 percent since July – before the European Central Bank began buying Spanish and Italian bonds in the secondary market to stabilise peripheral markets.
Irish CDS has also outperformed other euro zone strugglers, sliding 119 basis points to 605 bps over the same period while Spain’s climbed 168 basis points and Italy’s jumped 196 basis points, according to Markit data.
And Irish 10-year bonds have made total returns of 12.1 percent so far this year, second only to Italy in the euro zone, Thomson Reuters data shows.
Banking on a Portuguese bailout?
Reuters polls of economists over the last few weeks have come up with some pretty firm conclusions about both Ireland and Portugal needing a bailout from the European Union.
Portuguese 10-year government bond yields have hovered stubbornly above 7 percent since the Irish bailout announcement, hitting a euro-lifetime high and giving ammunition to those who say Lisbon will be forced into a bailout.
And of those who hold that view, it’s clear that bank economists have been most vocal in expecting Ireland and Portugal to seek outside help.
Take last week’s poll in which economists said Portugal would follow Ireland in applying for EU funds. Bank-based economists who expected a Portuguese bailout outnumbered those who didn’t almost three-to-one. For non-bank economists – those working at research houses, brokers and wealth management firms – the margin was only two-to-one.
This division was even more marked in the Irish bailout poll we ran three weeks ago. Bank-based economists expecting an Irish bailout outnumbered those who didn’t more than two-to-one. Our sample of non-bank economists were split almost evenly on the subject.
Interestingly, market makers and primary dealers – or banks mandated by government debt agencies to deal their new government bond issues – were staunchest in expecting Irish and Portuguese bailouts.
Of the seven economists polled by Reuters who work for primary dealers of Portuguese debt, six said Lisbon would need to apply for a bailout. For analysts representing primary dealers of Irish debt, four out of five said a bailout was imminent.
Europe’s over-achievers and their fall from grace
Ireland’s fall from grace has been rapid and far worse than that of its counterparts, even Greece. But life in the euro zone has still been one of profound growth, as it has for most of the other peripheral economies.
Take a look first at the progress of PIGS (Portugal, Ireland, Greece and Spain) GDP since 2007 when the global financial crisis took hold. In straight comparisons (ie, rebased to the same point) Ireland is far and away the biggest loser. Portugal is basically where it was.
But now take the rebasing back to roughly the time that the euro zone came together. First, it shows that Ireland’s fall is from a very high place. The decade has still been one of profound improvement in cumulative GDP even with the last few years’ misery. But it is front loaded.
Perhaps most interesting, however, is what the second graph (courtesy Reuters’ Scott Barber) says about the PIGS and the euro experiment. Despite major financial and market crises, Greece, Spain and Ireland have all seen their economies accumulate at a higher rate than the euro zone average. Only Portugal has been below average — a perennial slow grower.
Could any of this outperformance have been attained outside the euro zone? Probably not. But the question now is whether the current troubles are going to wipe out everything that has been achieved.
Political economy and the euro
The reality of ‘political economy’ is something that irritates many economists – the ”purists”, if you like. The political element is impossible to model; it often flies in the face of textbook economics; and democratic decision-making and backroom horse trading can be notoriously difficult to predict and painfully slow. And political economy is all pervasive in 2010 – Barack Obama’s proposals to rein in the banks is rooted in public outrage; reading China’s monetary and currency policies is like Kremlinology; capital curbs being introduced in Brazil and elsewhere aim to prevent market overshoot; and British budgetary policies are becoming the political football ahead of this spring’s UK election. The list is long, the outcomes uncertain, the market risk high.
But nowhere is this more apparent than in well-worn arguments over the validity and future of Europe’s single currency — the new milennium’s posterchild for political economy.
For many, the euro simply should never have happened – it thumbed a nose at the belief that all things good come from free financial markets; it removed monetary safety valves for member countries out of sync with their bigger neighbours and put the cart before the horse with monetary union ahead of fiscal policy integration. But the sheer political determination to finish the European’s single market project, stop beggar-thy-neighbour currency devaluations and face down erratic currency trading meant the currency was born and has thrived for 11 years.
Now the budgetary and bond market upheaval currently afflicting euro member Greece and stalking Portugal, Ireland, Spain and Italy has reawakened the whole debate. “Will the euro survive?” seems a legitimate question once again.
Apart from financial analysts, Paul Krugman seems to have made his peace with the euro’s existence but he still reckons it was a bad idea. Eric Maskin thinks financial markets are right to question the future of the single currency. And much is being made once again of Milton Friedman – high priest of 20th century monetarism – having reportedly said in 1998 that the euro would not survive the zone’s first serious economic downturn.
But having an opinion about the euro is not the same as knowing whether it is going to survive. And this is what most annoys those who have money at stake. Plugging in a new set of variables into complex econometric equations is probably not going to get any of these experts closer what happens next. Hanging around the corridors of power in Brussels, Frankfurt, Berlin or Paris is likely to prove more fruitful.
In the 1990s, many financial strategists in London, Manhattan and elsewhere often confused what they thought should happen with what was likely to happen and got the call wrong on one of the most far-reaching monetary events of the century.
Nice piece Mike.
Looking at the debate raging in the Spanish press, the comical spat with FTAlphaville, and so on, I’m in two minds as to whether the penny is dropping in the biggest domino Spain (or is it the UK?).
In recent times, Spain has demonstrated its capacity to slash its fiscal deficit. But go further back and the country has a long history as a defaulter. Spain’s relatively nasty and federated internal politics is also a barrier to reform.
What is clearer is that the crisis has revealed the fundamental imbalances within the Spanish economy that will ensure Spain is a euro zone loser for some time to come. Seeing Spanish (and other) government ministers kow-towing to the City with begging bowls will also give a whole new meaning to mainland Europe’s obsession with perfidious Anglo-Saxon economics.
