Friday, October 28, 2011

Euro Deal Euphoria or Wake?

The announcement of a euro deal emerging from the EU Summit on the "debt" crisis yesterday pleased the markets, but it has solved nothing  and appears to have a 100% chance of failure.  In fact the deal only further exposes the the fundamental construction weaknesses and limits of the euro which has doomed it to failure.

How far can you kick a can down the road with a dead cat inside?  Apparently, only one day.  Italian bond yields exceeded 6% at auction today.

Auerback, Wolf, and De Grauwe, among others, have called for the ECB to step up and be a lender of last resort consistent with the role of a central bank.  Unfortunately, the ECB by Treaty construction and ECB rules and establishment is not a real central bank and does not have the independent authority to buy bonds, issue currency (the NCBs issue currency under a rigid ratio per nation with the ECB limited to 8% for clearing purposes), or provide liquidity without difficult collaterization guidelines being met.  The ECB in setting interest rates has shown an inclination to be overly concerned with headline, rather than core, inflation which has caused rates to raised at least one time to far and maintained unchanged rather than lowering rates which has primarily served Germany and France at the expense of the deficit countries.  The ECB can only buy bonds on the secondary market and only of prescribed credit quality.  In its attempts to buy bonds on a limited basis to assist in relieving credit pressure and yields, it has faced significant political opposition from surplus countries which has caused it to act as a Fiscal Enforcer and threaten and/or hold back needed liquidity to NCBs in Ireland, Greece, Portugal, and Italy to force national politicians to enact budget cuts and austerity measures despite no public support in those countries.  The role of a real central bank is monetary policy with the ability to provide liquidity, buy bonds, set interest rates, and promote monetary stability as well as act as a clearinghouse.  To get the ECB to act as a real central bank would require Treaty changes and a complete change in the rules and functions of the ECB.  There is not enough time.

Trichet has even recommended a Finance Ministry for the eurozone, but what good would a Finance Ministry have if there is no fiscal transfer mechanism, eurozone taxing authority, and relinquishment of national sovereignty by member countries?  The EU and the eurozone has suffered for too long the determination of sovereign policy in member countries by an elite which is defiant of democratic approval.

Munchau has repeatedly expressed doubts on the leveraging proposed for the EFSF and the SPV which will apparently be created.  Has everyone forgot how disastrous the big banks SPVs were going into the recent Great Financial Crisis?

Sarkozy is promoting the involvement of China when this would only worsen the economic problems as I and Tim Duy have written citing Michael Pettis.

The 50% "voluntary" haircut is not enough and it is unlikely there will be 100% private participation and 1.4 trillion euro EFSF funding is not enough, particularly if European bank's liquidity and recapitalization is eventually challenged.  Additionally, it is popular to overlook the very negative direct effect these haricuts would have on Greek banks if Greece stays in the eurozone.

Many commentators have questioned the jury-rigged euro deal's attempt to structure 50% haricuts as not a defined default triggering CDS.  In fact, in just one day, Fitch has said the 50% haircuts do constitute a default and will affect Greece's credit ratings send the euro down.

The eurozone crisis band aid approach of temporary patches is not sustainable and is just setting the stage for recession and the eternal re-emergence of the very same problems.

Is the eurozone a monetary union with a stable currency benefiting all of its members or is it a tontine in which the last remaining country becomes the Imperial power and the other countries its colonies?  Meanwhile, Greece, Ireland, Portugal, Italy, and Spain are being repeatedly raped and France has been moved to the credit rating coming attraction.


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