Euro crisis: “Que Sera Sera…”

The European Central Bank’s “sticking plaster” appears to have had the desired effect of alleviating pressure on Spanish and Italian government bonds.  For now.  As BBC business editor, and still everyone’s hero, Robert Peston, observes

It would have been utterly disastrous if there had been any other outcome.

Because – for the avoidance of any doubt – the ECB is taking a substantial reputational and financial risk in buying the debt of these nations: many will see the ECB as taking a serious credit risk in bailing out two financially over-stretched governments and as behaving contrary to the rules of prudent central banking.

But, for now, investors and creditors care most that someone – anyone – is buying Spanish and Italian government debt. And they’re not desperately worried by the long-term risk that confidence in the intrinsic value of the European currency could be undermined by the conversion of government debt shunned by commercial investors into cash.

Stock markets are a different matter, as a BBC report notes

Analysts gave a mixed reaction to the ECB’s move, and said the markets would be hoping to see more action from European policymakers.

“The markets are looking for a concrete plan out of Europe and the US in terms of how they are going to deal with their deficits and those plans need to be implemented,” said Richard Hunter at broker Hargreaves Lansdown.

“Until the market can get comfort on these matters, there is going to be more volatility.”

The intervention by the ECB is seen as a short-term measure to help calm stock markets, but what investors want to see most of all is highly-indebted countries reducing their levels of debt, by spending less and raising more in revenues.

And as Robert Peston pointed out earlier

Here is the relevant statistic. Over the next five years, Italy has to borrow more than 500 billion euros, simply to repay existing debt that is set to mature. On top of that, Italy will have to borrow more to finance its deficit, the gap between tax revenues and spending.

To put it another way, Italy’s potential financing requirements on its own would exhaust the resource of the EFSF, based on its current size, if investors were to shun Italy altogether.

That is why investors see any purchases by the European Central Bank of Spanish and Italian debt as – at best – a sticking plaster. ECB purchases would not provide long-term sustainable demand for Spanish and Italian bonds.

The sticking plaster is only useful if it gives Italy and Spain sufficient time to persuade the markets that they have their deficits on a sustainable downward trend and their public finances are being properly fixed.

But if in the coming weeks Italy and Spain fail to do that, declining confidence in their ability to repay their debts will look even more like a potentially mortal wound for the eurozone.

The Irish Times’ Derek Scally has a close-up view of the domestic political pressures in Germany.

Merkel returned from the Dolomites to Berlin over the weekend but is remaining on holidays, ostensibly not to scare markets, even if she is spending hours on the phone.

As far as she is concerned, the measures agreed at the EU’s summit on July 21st – to be ratified by national parliaments next month – are enough to guarantee the euro’s future.

Everybody involved has an interest in making sure that what was agreed is enough, said one finance ministry official yesterday. “The markets, too, have to have an interest that we pull through,” said the official.

In addition, Merkel and French president Nicolas Sarkozy (pictured together above) have promised “extremely ambitious” proposals to transform the European Stability Mechanism – the post-2013 successor to the current European Financial Stability Facility (EFSF) – into a European Monetary Fund with robust powers of national budgetary oversight.

Until then, Germany is determined to face down calls to enlarge the size of the EFSF for Italy or anyone else, fearing the euro zone’s rescue ring would start to sink.

“Any increase in size would only be an invitation to speculators to find out how much the euro zone is still prepared to give,” one senior unnamed official told Der Spiegel magazine. And the official had a warning to Rome: “An economy like Italy’s cannot be supported” by the EFSF.

And what of the eurobond? Even mentioning the word prompts a bad-tempered reaction in Berlin. German politicians fear such an idea would be a tough, if not impossible, sell to their voters, particularly if it weakened the reform zeal of struggling euro-zone neighbours.

“We don’t think much of any plans to socialise European debts, particularly as Germany is one of the few countries who would have to carry such a guarantee,” said Horst Seehofer, head of Merkel’s Bavarian coalition partner, the Christian Social Union, last night.

That’s the “European Monetary Fund with robust powers of national budgetary oversight” hinted at by eurozone leaders after their emergency summit in July.

As the BBC Europe editor, Gavin Hewitt, points out, the start of that process, the new powers for the EFSF, “have to be approved by national parliaments and that won’t happen until September”.

Herein lies the major dilemma – particularly for Germany. It looks at countries like Greece, Italy and, to a lesser extent, Spain, and asks: If it is to guarantee their debt, how could it ensure that the old practices – the failure to collect tax, the excessive regulation, the resistance to change – would not just prove a drain on the German economy?

It is certainly true that Europe’s leaders have failed to tell their electorates the scale of the change that will be required. The public sector will have to be slashed. Spending on a whole range of desirable projects will be cut. The old Europe, so attached to its social welfare programmes, faces an uncomfortable decade. To bring in such unsettling change requires credibility – and many leaders like Berlusconi don’t have it.

In the end Europe faces a stark choice: to force some of the weaker countries out of the eurozone or for the stronger countries to assume responsibility for the bloc’s debts as a whole.

From the sidelines, many voices say that the answer to all of this is to launch a eurobond that would essentially turn national debts into common European debt. Borrowing costs for weaker nations would come down because their debt would have countries like Germany behind it.

Phillip Souta of the research group Business for New Europe says: “Germany and other creditor eurozone members can break this vicious cycle by agreeing to the joint and several guarantee of a eurobond.” The German Institute for Economic Research reckons a eurobond would cost Germany 15 billion euros a year.

In order to get close to selling this idea to the German public, the weaker countries would have to agree to a massive loss of sovereignty. Germany, France, Austria, Finland etc (the creditor countries) would essentially want to manage the tax and spending of countries like Greece and Italy.

We are not at that point, but the history of this crisis is the speed at which the unimaginable comes to be accepted.

Yesterday’s Observer editorial had something to say about that leadership too.

So far leadership in the eurozone – from Merkel to Berlusconi and from Jean-Claude Trichet, boss of the ECB, to José Manuel Barroso, president of the European Commission – has fallen woefully short. They have emerged as leaders who do not lead and are only ever forced to act at the 11th hour.

Now is the time. It is in no one’s interest for a disorderly collapse of the euro. It is time for the leaders of Europe, the ECB and the EFSF to get ahead of the markets. But that will not be the endgame.

Once stability is achieved, and in order to ensure that the euro has a future that cannot be doubted, leaders will need to confront far bigger issues. Either a mechanism has to be found to allow a two-speed Europe where the countries of the periphery are not hobbled by an exchange rate that is totally inappropriate for their economic wellbeing, or the eurozone must consider political union where the more prosperous areas routinely help the less well-off. The United States of Europe is probably the only true long-term solution.

[Europe is still sexy! – Ed]  Of course it is.

As I’ve been saying, for supporters of the “European Project”, the options are stark.

And when it’s that serious, you have to lie…

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  • huntsman

    All this drama will ultimately be in vain. As a system the Euro simply cannot work. You cannot have the ECB acting as the German Central Bank and messing up the economies of States which have different (more liberal and open) economic models.
    The only answer in the long run is to establish centalised eurobonds which Germany cannot agree wth since it would greatly increase its cost of borowing. It is currently 2.3%, even lower than German inflation. Eurobonds would have to pay a lot more.

    The other more rational solution would be to break the euro system up with Germany and the Dutch and a few other states taking over the current euro and the others; the peripherals and France moving to a looser form of monetary linkage.

    The Politans will try to defy economic logic but in the end will have to concede. The present solution of buying Spanish and Italian bonds is a band aid attempt to stop the inevitable.

  • Neville Bagnall

    Is what is happening at the European level that unusual? Has Europe not always been about painful and protracted negotiation, half measures, compromise and incrementalism?

    Of your stark choices, are we not slowly heading down the fiscal union route? But in a very European way, each step in that direction is (rightly) taken reluctantly. At some point an equilibrium will be reached between crisis solving interdependence and common interest on the one hand versus national competitiveness and advantage on the other. It won’t be pretty but will mostly work.

    Will the end point be Eurobonds? I don’t know. Maybe. But only if there is no other choice.

    We don’t have a common European polity, so expecting anything else is unrealistic. It will be interesting to see if a Super-Commissioner emerges out of the process, the economic equivalent of Lady Ashton. If it happens, expect the position to be significantly more relevant, effective and desirable than hers, or perhaps any other European role.

    I don’t subscribe to the idea that the Eurozone will break up, less still that it would be desirable for Germany. Nor do I think that it is inherently unworkable.

    For example, Ronan Lyons makes some useful points, particularly about the extent to which the EU already has US levels of fiscal transfers.

    And Stephen Kinsella points out graphically (as others have before) the extent of the competitive benefit Germany derived from Euro membership and its decade long stagnation. Losing that competitiveness by leaving the Euro would be very painful.

    Would it be nice if there was clear decision making and a quick solution? Sure. But the price of checks and balances (not to say democracy) is often procrastination and crisis. If anything, I find it reassuring.

  • tuatha

    It’s going to hurt like hell when that fiscal ‘sticking plaster’ is suddenly ripped off, as it one day must/will be. Let’s just hope that the lesson every child learns is recalled, slowly, hair by hair is worse.

  • Is not what is talked about in this short video …… …. happening even as London is burning and the markets are tripping their safety levers to not implode and collapse, which is what suspension of trade, whenever there is too much of a negative swing in the markets, is designed to do …. in a rigged market which is not free to reflect the reality of the global situation.

    Or do you not see it happening all around you? I suppose whenever QE3 is released, it will be more apparent and impossible to then deny?