The EU Stabilisation Plan

After the excitement of the weekend’s EU announcement, the question most people will ask is “will it work?” I think the answer to this question depends on what we mean by “work”.

There are obvious parallels here with the banking crisis. As markets began to doubt the solvency of many institutions, including the Irish banks, access to short term liquidity dried up for these institutions. Governments provided various liability guarantees to help these banks regain access to markets (ours being the most extensive) but these guarantees did not change the underlying solvency picture. Ultimately, the problem of insolvent banks had to be dealt with via costly recapitalisation measures, a process that we in Ireland have yet to complete.

The size of the funds announced in the EU deal are large enough to most likely ensure that, for a while, no EU country will fail to roll over its sovereign debt. In that sense it will most likely work. But it doesn’t change the fiscal reality.

Last week’s €110 billion Greek deal wasn’t well received by the markets because it still seemed to imply a Greek default was on the way. Last night’s announcement is being well received but then it doesn’t actually come with a concrete fiscal restructuring plan for Portugal, Spain or Ireland, so the plan can be taken good news without having to question any dubious underlying assumptions about fiscal sustainability. If the time comes when this fund is tapped but the markets don’t buy the stabilisation plan announced, the situation could unravel again.

Most of the thoughtful reaction elsewhere points to it being a long and complicated road ahead. The Baseline Scenario guys give their reaction to the plan here. Arthur Beesley also has a nice piece in the Irish times here.

30 replies on “The EU Stabilisation Plan”

Who’s that hiding in the corner under the lampshade with the big nose and big ears? This is a great day for the E.U.S.S.R! There is no going back now. Hats off to all the euro elite who have mapped out this economic strategy to inexorable ‘ever closer union’.

@ Paddy, from Reuters’ feed:

GERMANY’S MERKEL SAYS WE MUST ADDRESS THE ROOT OF THE PROBLEM, THAT MEANS CONSOLIDATING BUDGETS

@ Karl

Any thoughts on the medium-term inflationary effects of the ECB’s involvement in the bond markets? They’re stressing that the intervention will be sterilized, is this really credible though?

Baseline asks:

‘Will the ECB buy a great deal of Greek debt? We doubt it since this constitutes a clear, large credit risk’

Commentator George sees it this way:

‘Most of the 750 billion will go to retiring upcoming maturing bonds, many of which are due to private banks. So, in postponing the day of reckoning, the debt and the attendant default risk will be “seamlessly” rolled over into taxpayers’ hands. The seniority of the new debt to the existing debt is therefore a smokescreen for the fact that politicians have once again bailed out private banks at the expense of taxpayers’

There is a multilevel game going on. The markets provided Irish banks with wholesale funds ad lib on the understanding that the nation state would pick up the tab when the property crash came. That bet was correctly seen as one way because the banks were ‘systemic ‘ at our national level.

The same markets also lent merrily to mismanaged sovereigns on the understanding that they could pass the losses on to the ECB when the fiscal chickens cam home to roost. Another correctly calculated one way bet, on this weekend’s evidence.

Peripheral European sovereign funding does seem to have a major systemic effect on credit markets. Whocudanode that such a thing can happen within Europe ?.

The fire is spreading from the big Euro banks to the ECB. As @ Robert Browne pointed out on another thread, the Germans are going to be looking hard for the exits. All the old ones are blocked off, so they’ll be needing a bit of help with that.

From the Q and A to last Thursdays press conference

(accessible at: http://www.ecb.int/press/pressconf/2010/html/is100506.en.html)

Q: The first one is: is the purchase of government bonds an option to fight the consequences of Greece’s fiscal crisis on financial markets? Did you discuss this option today?

A: … On your first question, we did not discuss this option.

…

Q: You said you did not discuss the option of buying government bonds. Can you consider discussing it in the absence of deflationary dangers in the euro area?

A: On the sovereign bonds, I have already said that we did not discuss the point.

This was three days before the announcement. Seems to me that the bank’s credibility has to be shot.

It will not work because it is not moral… It is based on coerced corruption, debt and thievery (inflation). This will bring no justice or peace. Here is a bit of info:

In 787 Charlemagne established a new system of currency, higher standard. England’s King Offa adopted this system. It was so sound that it was continued to be used until it was dropped by the United Kingdom in 1971.

http://books.google.de/books?id=bQlJP9O9hKkC&lpg=PA97&ots=Rifs9N_c1b&dq=John%20J.%20Butt%20charlemagne%20mint&hl=en&pg=PA99#v=onepage&q&f=false

PJ
They are entitled to lie in order to minimize notice to these pesky speculators. Aka capitalists.

http://www.tribune.ie/news/article/2010/may/09/mortgages-and-loans-to-go-up-after-greek-crisis/

As predicted! Inflation of consumer goods, food etc will also accelerate with the devaluation of the fiat euro. All in all, pretty much a perfect storm. Thank God we can rely upon GFF to govern wisely, else other things might go wrong. 😉

All
The Aussies have a financial year based on nature, ie winter occurs promptly every 30th June. Therefore, we have a federal budget tomorrow. Read and wonder!

It is heartening that they came up with $1,000,000,000,000 euro in monetizing debt at the stroke of a keyboard. Anyone want to say what the consequences will be even if the debt spreads decline again?

I don’t know what will happen. But I think that the system will be in need of total debt forgiveness and a new store of value by 2018. Will that happen? You need a moral people to make that happen.

@ Paul Jackson

A central bank governor has to say yes or no not maybe. The council may not have discussed the issue but that does not mean that the issue was not discussed within the ECB. Assisting hedge fund managers is not part of the job spec.

Trichet did use the code “permanently alert” several times and he also used the term  “non-conventional.”

It’s well that central banks in this crisis are not slaves to convention and dogma.

@ all

Economist columnist Charlemagne writes: “I think that the politics have shifted dramatically in the last few days, and that the euro is looking less German and more French, even if Angela Merkel has won some late victories on process by insisting that national governments should not give open-ended loan guarantees to the European Commission to play with. I think that the EU has developed a much stronger external narrative, telling markets that they should treat the eurozone as a single whole, which is strong and solvent, and not try to pick off weaker members because they will get their fingers burned.
But, and I think this is still a big but, the political narrative inside the eurozone is still lagging way behind. If the markets outside are being told to treat the eurozone as a single fortress, defended by unlimited budgetary firepower from the rich members of the club, voters in places like Germany, the Netherlands or Finland are absolutely not being told that they now inhabit a single economic entity, in which big chunks of the budget are pooled.

Instead, the political messages being delivered internally are heading in quite different directions.”

http://www.economist.com/blogs/charlemagne/2010/05/euro_crisis_2

@ Michael/Paddy

Michael is correct. Trichet was quite specific in saying that they had not discussed this at the Governing Council, which is a formal monthly meeting. This is essentially a plausible deniabilty situation where he would not have to admit that they had been discussing it, given its highly controversial nature, especially as im sure they were well aware that something was about to happen over the weekend.

There is nothing more difficult to plan, more doubtful of success, more dangerous to manage, than the creation of a new system.

–Niccolo Machiavelli

@ Karl,
I disagree that there is no fiscal restructuring plan for Ireland, Portugal etc.
The Stability and Growth Pact has automatically created restructuring plans for all of these countries already.

This is a glorious day to wake up and find out that the German and French governments have decided not to bail out their domestic banks directly. Instead they have demonstrated their faith in the future of EU and the Eurozone by rallying the other solvent members of the Union and coming to the aid of the insolvent and near insolvent members of the Union. Those who were forecasting that Germany would act in its own narrowly defined self interest and succumb to short term poltical expediency have now been put in their place. When the Frankfurter Allgemeine softened its anti bailout stance a few weeks ago it was an indication that the firmly held position of Frankfurt and Basel bankers was in the ascendancy. The German saying that what doesn’t kill us makes us stronger will now come true if we all live up to our responsibilities and give careful consideration to what we are voting for in coming elections. Will this work, it will because the alternative is highly unpalatable. Will the Sovereigns cede some power to Brussels, Strasbourg and Frankfurt, decidedly yes and that is a good thing.

I should probably know better than to try to make any sense of currency movements but I find it interesting that the euro has given up most of its gains against the dollar as the day wore on. Closed at 1.27 on Friday, jumped up to a peak of 1.31 today and has now fallen back to 1.28. Perhaps the initial euphoria is wearing off a bit.

@KW

I think we should look at the reaction of the bond markets rather than the currency markets.

As has been proven so often recently, a week is along time.

If the arrangements look credible by this time next week, we will be able to breathe more easily.

In the meantime, there are a lot of guys holding their breaths and about to turn blue…

Re: Die Welt

It is the third article from the top entitled “So what lies in the Euro Zone” which links to the article “So what lies further in the Euro Zone”

The price of another government guarantee:
http://news.bbc.co.uk/2/hi/business/10106105.stm

Government interventions in the markets should be short. This one? It will be in place for as long as the “market” believes it is “necessary”. Money managers will make more money for as long as they believe the guarantee to be necessary. Anyone willing to hazard a guess how long that will be?

Creditworthy nations will pay more for their borrowing while this guarantee is in effect. I’m guessing their extra cost will not be used as provisions for losses by anyone lending so we can expect some nice profits in banks soon. There are probably worse ways of deficit spending to get an economy starting than overpaying banks for borrowing, although I can’t think of any just now.

Btw, I read about shock and awe strategies. It was used in both Iraq and Afghanistan. Shock wears off, awe as well. The stabilisation effort in those two countries have been ongoing for quite some time. I do hope that this stabilisation plan has more to it than the initial shock and awe.

Arthur Beesley in the Times:

“Such figures (the €500bn or €750bn) take no account of the hundreds of billions that might be involved in a new European Central Bank (ECB) intervention to buy up government debt from euro countries. This provides an alternative source of funding for distressed euro countries if the private market dries up.”

So the chnage in ECB policy to buy soverign bonds, I am still a little unclear on two aspects of this myself:

1) If the 500bn doesn’t take the ECB’s new involvement in the soverign bond market into account, then is it going to be a sustained change of policy by the ECB rather than a very short-term one? i.e.: It would continue buying bonds even after the €750bn is either used (unlikely) or no longer necessary?

2) Is the ECB going to participate in auctions or will they just buy the soverign bonds from existing buyers (secondary market)?

EDIT: Maybe that was unclear.

Basically, is the buying of sovereign bonds completely seperate to this €500bn?

@ Rob

the ECB bond-buying is supposedly ‘sterilised’, ie they will sell an existing asset before they buy a Greek/Portugese/Irish/Spain/Italian bond. Hence (a) it is not technically QE, (b) it therefore does not require anything from the 750bn and (c) it should not technically be inflationary (i say technically, as there is a lot of debate there).

Also, they are only buying in the secondary market, so they will not be involved in directly affecting the price of a sovereign issue, and should only be providing support and/or a floor for the market. Indirectly they will obviously make it easier/cheaper for sovereigns to issue debt.

Rob,
How do you think they will sterilise this? The logical way would be to sell German/Dutch/etc bonds and buy an equivalent amount of PIIGS bonds. I just don’t see how this will be politically acceptable in Germany, the Netherlands, etc. I feel that the consequences of throwing out the rule book during a weekend of panic will be disastrous.

@bp
I hadn’t given sterlisation measures much thought to be honest but your presumption seems as logical as any to moi.

McArdle in the Times yesterday said every euro used to purchase a bond would be mopped up “by either getting it back on deposit or other means”.

Not entirely sure what is meant by getting it back on deposit.

Comments are closed.