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European Fiddling While The Currency Burns

Wednesday July 20th 2011

 
European Fiddling While The Currency Burns

There are now less than 24 hours to save the currency...will it happen, will the great and the good of European find a comprehensive package?

Not likely!
 
Just yesterday the German Chancellor, Angela Merkel stated that the crisis enveloping the Euro Zone (EZ) will not be solved in one go. So she has sent a warning shot across the bough of the good ship "Euro-Phoria" ... do not get too excited about the chance of a solution.

Here at Spotlight we feel we have to ask the question how many attempts at a solution does the EZ require? This crisis has not just suddenly arrived, it has been building for several years. I would even say in the Greek case, since 2000 when it was allowed into the EZ on a false declaration of fiscal responsibility.
 
In an attempt to pressure his fellow European leaders inaction, the Greek Priminister, George Papandreou said in Athens on Tuesday that EZ leaders have to show tomorrow that they can resolve the EZ debt crisis to avoid a virulent contagion that will  envelope fellow "Club Med" nations, Italy and Spain.  we say forget "contagion", the Med is contaminated!

Still the Greek PM has to earn some credit for his willingness to fight like a Spartan at Thermopylae.
policy makers are poles apart on how to persuade investors into financing a new bailout package and whether the 17-nation euro area should issue "€ Bonds" to help debt-laden nations across the bloc tap markets. Whilst there will not be a comprehensive solution tomorrow, what could result is a willingness to press ahead with the € Bond proposition. Given that 65% of the Eurozone, by GDP weighting is rated AAA/AAA a 5 year maturity would probably yield just 40 bps over equivalent maturity Bunds.

What a hard sell that will be for 3 reasons:
,
 
"...It could be a make-or-break moment for where Europe is going...Markets are saying pretty much what I’m saying too: that Greece is doing what it can, but that Greece is not going to be able to carry the weight of all of Europe and the other problems that Europe has...”
 
I do have to admit that his statement takes my breath away. The sheer arrogance of that view that the markets think Greece is doing a splendid job. The truth is that the markets are shunning Greece because they have limited faith in the progress path. Greek 2 year yields rose above 40% yesterday for the first time, adding as much as 144 basis points (bps) to trade at  40.46% before recovering to 39.01%, little changed from Monday. Over 2011 one can see that German debt has returned +2.4% whereas Greece has lost 23.3%. As a reference, the US which has its own debt/default issue in play has gained 3.8% (Source:  European Federation of Financial Analysts Societies and US Treasury).  At the 10 year level the the premium on Greek debt was 1,556 bps over Germany.
 
Looking ahead to the summit on Thursday it is completely clear that the only issue on which there is agreement is that there is no agreement. From across the EZ
 
1) Does the EZ have to create yet another European Authority that is responsible for the bonds? That itself will require a funding budget!
2) If no new authority will each EZ national have to (a) back up a proportion of the issue amount? (b) Add that amount to their national debt total?
3) Convincing the electorate/tax payers in stable nations that they have to fund the profligate is hardly going to be a vote winner.
 
Papandreou, has unsurprisingly spoken in favour of issuing such securities. he said that such sales would create             “a sense of security.”  Of course he would as he is the beneficially of a free ride on the backs of others in the EZ. Of course the idea is unloved in Germany as Thomas Silberhorn, European Affairs spokesman for Merkel’s Bavarian Christian Social Union said yesterday that   € Bonds were seen as an overstretch of solidarity between the region’s members.
 
It still puzzles me that as despite the simple fact that one currency and one interest is impractical across so many diverse nations that the call is for even greater fiscal integration. There are many and I respect their work, in particular that of  John Clarke, Chief Investment Officer at GHC Capital Markets, but I dissagree with his belief that political union would have seen the Euro Project be a success.

So many laws come down from Brussels already that because they have to cover such a diverse economic and social region are actually ineffectual; they are just annoying. However, even though we have President. most European couldn't spot President Herman Von Rompuy in a lineup. So to me it just seems rediculous that Europe would settle for a full blown central European Government. Who would lead it? it would be just like the European Council of Ministers, but on sterioids, and that equates to a lobby where France and Germany get their own way everytime. it just doesn't wash to compare the EZ to the USA. the former has been at war within itself many times in the past 200 years. The latter was born as a single nation of oppressed souls that sought a new freedom.

By surrendering currency and central sovereignty to the € and European Central Bank, all member nations lost the tools of devaluation and monetary policy. If they seek over time to adopt a standard taxation policy then the only remaining lever held in Athens, Dublin, Lisbon etc...etc i.e. the tax rate will be surrendered as well. If we think we have seen nasty riots on the streets of Athens so far...just wait till tax policy for the Greeks is decided by a faceless bureaucrat in Brussels. Actually given that the Parliament is in Brussels and the CB in Frankfurt, then the Tax Office will probably have to be in Paris!
 
Beware a house divided:
 
There is hardly any "European Union" when it comes to finance. If ever the old adage "...it is all about the money..." rang true it is now. EU President Herman van Rompuy called leaders to a 2nd summit meeting inside a month to discuss the financial stability of the EZ as a whole and the future financing of the Greek program. The € fell on the major FX crosses and the Credit Default Swap costs of insuring European sovereign debt rose to records. The market simply doesn't believe the EZ region is closer to solving the crisis. Despite all the promises, all the summits and 15 months
since the first bailout for Greece.
 
The national leaders are at odds with the leadership of the ECB. President Jean Claude Trichet said on the 10th that Europe is at the “...epicenter” of a debt crisis that concerns the entire developed world..." he urged all in the and urged the EZ to do the maximum in terms of governance reforms.
 
It will be another dark day for the single currency and just one step closer to Greek default and Greek ejection of this disappointing club.

Stephen Pope

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