Thursday, February 11, 2010

Denial and the Pan-European Debt Crisis

As if the euro Trojan Horse was not being prominently offered, the European Union today issued a statement offering solidarity with Greek austerity measures but with no commitment to a solution to the pan-European debt crisis which is unfolding.  And the European and US stock markets went whistling along as if no solution was the shadow of a solution.  Hope driven stock markets which ignore reality are very unhealthy signals. 

In fact, the solidarity but no commitment statement implied that if there is any assistance to Greece it will not be in any form which acknowledges the euro as a multi-national currency which inhibits its euro nations from exercising a complete sovereign fiscal policy within their nations and the failure to provide the ECB with the economic tools, available to any national central bank with its own currency, to respond to the economic conditions of individual euro nations.  The design failures of the euro and the ill-conceived economic restrictions imposed by the Stability and Growth Pact were destined to yield a financial crisis.

German sentiment continues to be very divided, because it has enjoyed a positive euro exchange rate in comparison to other countries, such as Greece, Spain, and Portugal.  The Frankfurter Aligemeine today editorialized that Germany should return to the deutschmark and denies any European Union responsibility for the economic stability of its members.  This is a position which denies the reality of German banks exposure to the euro nations with significant leverage problems:  "German exposure to the region amounts to €43bn in Greece, €47bn in Portugal, €193bn in Ireland, and €240bn in Spain, according to the Bank for International Settlements. German lenders are already vulnerable, with the world's lowest risk-adjusted capital ratios bar Japan."

It is estimated that two-thirds to 77% of Greek debt is held outside of Greece: France with $75 billion, Switzerland with $64 billion, and Germany with $43.2 billion.  The contagion has already affected Greek banks ability to roll over repo debt. On the European banking scene, the exposure risks also include those of the Baltic states who have their own currencies, but the currencies are pegged to the euro.

It appears if any patchwork assistance is provided to Greece, it may well require a further surrender of national sovereignty rather than creating a European bond as I and others, such as Marc Chandler, have suggested.  Brussels is proceeding down the road of political compromise rather than seizing the problem by its causes and solidifying a core Eurozone with a currency and an ECB that acknowledges the exchange rate competitiveness gaps, the need for a European bond, the need of individual member nations to exercise sovereign fiscal policies,  and the need of an ECB with the economic tools to assist individual member nations and coordinate within the European Union.  At the present time we have a 20 billion euro liquidity problem, but the Eurozone will need to finance approximately 1.6 trillion euro of debt in 2010.  Ineffectual political compromise will engender a pan-European debt crisis which would ripple across Europe and around the world.

In discussing Greece, which has a relatively small economy, Spain, which has a much larger economy, is often mentioned as a possible next focus of the pan-European debt crisis, but Italy and Ireland are right up there with Spain with significant public and private bank debt.  They all have excess leverage and are suffering from public fiscal problems which have been facilitated by a negative euro exchange rate and inhibited by the Stability and Growth Pact.  Which will be next?  Greece could just be the training exercise as the derivatives traders hone their skills to wind the deficit hawks up and harvest larger CDS trading profits.

The rest of the world should not be waiting.  The UK had a failed bond auction in March of 2009 and has recently stated it may need to inject more cash into its economy.  Germany had a failed bond auction in January.  The 30 year United States treasury auction with its high yield and 24% direct buyers is considered by many as a weak failed auction today.

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