Tuesday, February 9, 2010

The Unfolding Pan-European Debt Crisis

The stock market, desperate for any irrational exuberance, is trading up today on the "hopes" of a European solution to the Greek economic troubles, while the actual information is extremely conflicted and indicative that a European solution is not yet nascent.

Trichet is returning early from the Australian conference of central bankers fueling speculation that the EU would have a special meeting, although ECB governors were again reaffirming the ECB does not have clear bail out authority and any decision to help Greece must be a political one.  The constant refrain is Greece must carry out its EU austerity plan.  In the meantime, a new EU economic team has been formed and there is speculation that the ECB unannounced exit plan may have to be delayed if it threatens to further destabilize market concerns about Greece, Spain, and other euro monetary countries.

We have previously documented that the banking problems in Greece, Spain, Portugal, and Ireland have all led to budgetary deficit problems and called for the EU and ECB to create Euro bonds to help solve the problem, because we do not think the IMF possible solution will be acceptable to the EU or Greece, because it also does not address the problem of a multi-national currency with no monetary policy to correct national competitiveness gaps which significantly limits national fiscal policies.  Greece has publicly said an IMF solution would send the worst possible signal.

The global debt controversy, which swings between deficit hawks and the efficiency of targeted economic spending, is overplayed even to the extent of what would be a proper Keynesian action plan.  German sentiment clouds both economic debate and what is best for the EU as a whole.

The EU needs to get its member nations to put the problems in perspective.  It is an opportunity for the EU to stand up and directly address the problems caused by a multi-nation currency in individual euro countries, who no longer have monetary policy options available to coordinate with fiscal policy.  The fact that the Eurozone is not an optimum currency area is obvious, but the creation of a two-currency European Monetary Union does not solve the multi-nation individual country economic problems relative to the multi-nation currency; it would only be a synthetic end run around a crumbling bridge.

Joseph Stiglitz is calling for national authorities to teach the derivatives speculators a lesson.  As Stiglitz has documented, another part of the problem is how Goldman Sachs helped the prior Greek government hide debt.  Yet, the primary hedge funds involved in driving the derivatives attack on Greece and Spain, which also drives the CDS costs of other nations up globally, are those of Goldman Sachs, J. P. Morgan, and three other hedge funds.  These attacks on sovereign debt for transitory profit are an example of a systemic risk which could throw the global economy into a double dip and depression.

While the myths and facts of this Eurozone debt crisis are many and not being fully debated and addressed for long term solutions, the final analysis is that failure to deal effectively and efficiently with the debt crisis risks sovereign debt contagion fueled by derivatives speculators and a global double dip into recession of unknown length.  The banks in each of these euro countries are intimately involved in the creation of this debt crisis which was facilitated by the euro and its effect on each individual country's economy in creating either asset bubbles or negative competitiveness gaps requiring public spending to pick up the slack of private spending or both. The excess leverage in the banking systems of these countries, and Ireland is the large powder keg in the background, is symptomatic of the difficult balancing act which must be done if a multi-national monetary policy is to work for the benefit of all member nations.  The leveraged banking problem is deep and significant; it is the problem which should be addressed urgently and is being masked by European Union monetary policy and the sovereign debt issues.  The creation of Euro bonds would be a step towards putting some flexibility in EU monetary policy and providing some teeth in individual member nation's ability to properly control their fiscal policy.  The alternative is a pan-European debt crisis which spreads from nation to nation around the world.  Ireland's bank debt dwarfs Iceland and the United Kingdom's debt level is even higher with government guarantees.  The EU and ECB need to come up with an end game that acknowledges the banking and sovereign debt as economic problems requiring monetary, regulatory, and fiscal coordinated responses, which facilitate fiscal policy responses appropriate for each member nation, and effectuate the euro as a true multi-nation currency.

Attempts to provide loan guarantees or otherwise put a thumb in the dike will not protect other EU nation's banks from the fundamental leverage problem and how it is acerbated by the euro.  Until a real, substantive coordinated plan actually emerges, the rumor mills will grind away.

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