Author: Colm McCarthy

From the FT’s rolling blog:

• Both Sarkozy and Merkel would prefer treaty change for all 27 European Union members. However, if this cannot be reached, they are happy to move forward with a treaty for the 17 eurozone members alone

• The treaty favoured by Sarkozy and Merkel would include automatic sanctions for countries that breach the rule on deficits below 3 per cent of gross domestic product

• Primary tool for enforcing balanced budgets will be a “golden rule” written into the constitutions of all 17 eurozone member states; to be verified by the European Court of Justice…..

 

Let’s cast our minds back to, say, October 3rd. 1990. An asymmetric shock (re-unification) struck the unsuspecting Bundesrepublik. The deficit, on the Maastricht definition, stayed below 3% until 1994 and then hit, hmmm, 9.5% of GDP in 1995. Gott in Himmel! 

The ECJ then pronounced that Germany was liable for ‘automatic sanctions’ and in 1996 ……

Juergen Stark of the ECB spoke at the IIEA today and they have posted a video on their website:

http://www.iiea.com/events/crafting-monetary-policy-for-stability-and-convergence

The summary of the proceedings, from the IIEA website, is:

 

‘Dr Stark delivered a keynote address to a packed house in the Institute on the theme of Economic Adjustment in a Monetary Union. Commending Ireland as a “role model” for other countries embarking on programmes of austerity, he nonetheless acknowledged that “strong headwinds” in the global economy threaten to blow its recovery off course. “The sovereign debt crisis has re-intensified and is now spreading over to other countries including so-called core countries.”

Dr Stark delivered a keynote address to a packed house in the Institute on the theme of Economic Adjustment in a Monetary Union. Commending Ireland as a “role model” for other countries embarking on programmes of austerity, he nonetheless acknowledged that “strong headwinds” in the global economy threaten to blow its recovery off course. “The sovereign debt crisis has re-intensified and is now spreading over to other countries including so-called core countries.”

He went on to argue that the crisis was not confined to Europe and that it was in large part a crisis of confidence. It is important that advanced economies do not talk themselves into a second recession. That said, many of these economies urgently need to pursue fiscal consolidation or else their debts will sooner or later become unsustainable. Dangerous fiscal positions are often compounded by structural weaknesses and these too must be addressed. The fiscal outlook for many states threatens the broader economic situation, as do persistent macro imbalances.

Dr Stark recalled that there has historically been little urgency attached to the problem of heterogeniety across Eurozone economies by European leaders. Rates of inflation for example varied widely across Europe in the years leading up to the financial crisis. Risk was inappropriately priced up to 2007 and there are governments that have never properly adjusted to the demands of monetary union, which were well understood by its architects. As far back as 1998, finance ministers and heads of state and government agreed that economic and monetary union should never be used as a justification for financial transfers.

Speaking to journalists after the event, Dr Stark said that “Eurobonds, even if they’re called ‘stability bonds’, won’t solve the sovereign debt crisis in Europe, because they don’t tackle the structural problems some countries are facing.” They “seem to be feasible at a later stage, but only after the transfer of sovereignty.”’

 

Take a look. I promise to let you know what I thought of his presentation when France hits AA+. If this is avoided without a reverse tap  (in Italy or somewhere!) from the ECB, I will devote the rest of my life to writing, on bended knees, the definitive history of the Bundesbank.  

Searching for politically acceptable policies is fine if the set considered intersects with market-acceptable solutions. Can the Italian bond market be stabilised without mobilising the ECB balance sheet?

The alternative instruments available are essentially a combination of support from reluctant secondary market interventions by the ECB and potentially the EFSF (including its new SPIV) and a credible Italian commitment to cutting the (small) budget deficit. The trouble is that the ECB will not commit to open-ended secondary market support, and is in any event intervening at interest rates which are too high. The EFSF is severely constrained in the short-run and the new arrangements to extend its balance sheet are stuck on the runway. Italy appears to have rejected an IMF standby (or not), and it could hardly have been big enough to matter anyway.

Early fundraising for the EFSF went reasonably well but Monday’s issue was a disaster. The spread over bunds is now outside France, Belgium next stop, has risen over 100 bps since the market debut and lenders have been unnerved by the continuing re-definitions of the status and mission of this supranational borrower. Klaus Regling’s pilgrimage to Beijing the previous week failed to secure any commitment to the new borrowing vehicle and the old one could be on negative watch before France. In any event a balance-sheet-constrained vehicle will always be tested. A bail-out fund paying large spreads with continuing uncertainty about its structure and mission, and which competes with sovereigns in the market, is in danger of itself contributing to instability.

The €350 billion required by Italy over the next year to fund roll-overs and the prospective deficit may not be forthcoming even with a credible new fiscal adjustment programme. Worthy long-term measures to raise the potential growth rate in Italy will not inspire bids at bond auctions. There may be no equilibrium rate above 6% or so.

European policy could be characterised as seeking sequentially the set of previously unthinkable measures needed to stop the rot and continually falling short. Working backwards, the bond and interbank markets could be stabilised by the following shock-and-awe package, with lots of moral hazard: 

– Hard default for Greece and for any other countries (not including Italy or Spain) which need them, calculated to make them unambiguously solvent on exit from their programmes.

– Compulsory re-capitalisation for the banks

– An ECB reverse tap in the Italian bond market

If this set of actions is politically infeasible, and if no lesser package will work at this stage, the inference is inescapable and will be drawn soon.

Bunbury, on another thread, writes

‘…one of the most unique …’

Oh Christ! The standard of English on this website deteriorates by the day. But then, no one thinks twice anymore when they see the phrase ‘close proximity’ (a ‘pleonasm’ in grammatical terms), so the disease has even encroached on the groves of academe.’

I am offering a prize for the reader identifying the most irritating current abusages of the English language. My personal favourites include ‘new initiative’ and ‘almost unique’ (means rare, I think).

The value of the prize to reflect the quality of the entries.

The summit communique contains the following:

’12. The Private Sector Involvement (PSI) has a vital role in establishing the sustainability of the

Greek debt. Therefore we welcome the current discussion between Greece and its private

investors to find a solution for a deeper PSI. Together with an ambitious reform programme

for the Greek economy, the PSI should secure the decline of the Greek debt to GDP ratio with

an objective of reaching 120% by 2020. To this end we invite Greece, private investors and

all parties concerned to develop a voluntary bond exchange with a nominal discount of 50%

on notional Greek debt held by private investors. The Euro zone Member States would

contribute to the PSI package up to 30 bn euro. On that basis, the official sector stands ready

to provide additional programme financing of up to 100 bn euro until 2014, including the

required recapitalisation of Greek banks. The new programme should be agreed by the end of

2011 and the exchange of bonds should be implemented at the beginning of 2012. We call on

the IMF to continue to contribute to the financing of the new Greek programme.’

 

I don’t quite see the point of going through a default (which is not, of course, a credit event) in order to get Greece down to 120% of GDP in 2020.

But note the very nifty €30 bill to be contributed by ‘…the Eurozone member states…’.

This could include little us! Imagine, the team taking one for France and we are allowed to tog out!  

What is being proposed here is that European investors who lost money in Greece are getting bailed out to the tune of €30 bill, not by their host governments but by the team. Those who lost money in Ireland got bailed out, and continue to get bailed out, by the host government only.

You have to hand it to the French.