Europe spins again

We are now stampeding towards god knows what in Europe. There is still absolutely no consensus on what, who or how the Greek issue is going to be resolved, and still absolutely no one is talking about the fact that without a full monetary and fiscal union, the issuance of true Euro bonds , or some productivity inducing medicine from out of space that the underlying issues get worse by the day and contagion continues to slowly push through the EU nations. Reuters reports again on the move into France.

France is increasingly under fire in the market sell-off that has deepened Europe’s sovereign debt crisis, judging by the poor performance of its stock and bond markets so far this month.

French stocks are down some 7 percent so far in July closer to the 8-9 percent fall seen in the euro area’s other highly indebted countries than a 2-percent dip in Germany.

Yields for its bonds, long viewed alongside Germany as benchmarks for European government borrowing rates, have jumped to as much as 74 basis points above Berlin’s 10-year paper.

Analysts say the fall is likely to deepen because of the country’s exposure to Italy, the euro zone’s third-largest economy. France will also have to bear the burden of further financial assistance to Greece, which needs a second multi-billions bailout package, and potentially others like Portugal and Ireland.

While investors have been clamouring for such an outcome, the countries who foot the bill are expected to suffer.

France “is being meshed into the contagion,” Philip Lawlor, investment strategist at Smith & Williamson in London, said.

“The sting in the tail could be that the last thing that the market wants to see is France and Germany commit enormous amount of fiscal transfer. Given that the French economy is not doing fantastically well …, I wonder whether credit ratings agencies will then turn around to France and say, I am not sure that your triple-A rating is as robust, and put a warning on it.”

France’s public debt will peak at 86 percent of national output next year, the government forecasts. Meanwhile IMF data provided by Lloyds Bank shows a forecast structural deficit of 4 percent of GDP this year, compared with 3.2 percent for the Netherlands and 2.1 percent for Germany.

Last night we saw Italian and Spanish bond spreads reaches new euro area highs before falling on the words of the ECB’s Nowotny.

European Central Bank council member Ewald Nowotny suggested the bank may compromise and allow a temporary Greek default as officials scramble to fix a sovereign debt crisis that’s spreading to Italy and Spain before a leaders’ summit in two days.

As Spanish financing costs surged at a 4.45 billion euro ($6.31 billion) treasury bill auction today, policy makers are trying to ease a split that’s pushed interest rates on Spanish and Italian 10-year debt above 6 percent for the first time since the euro debuted 12 years ago. The ECB has until now argued that any Greek default could spark a new financial crisis, derailing a German push to make investors help foot the bill for a second bailout of the country.

Those words now seemed to have been retracted.

European Central Bank Governing Council member Ewald Nowotny is in “complete agreement” with ECB President Jean-Claude Trichet on Greece, his spokesman said on Tuesday, after earlier Nowotny comments suggested he held a different view on the issue.

Nowotny had told CNBC in remarks aired on Tuesday that a solution to Greece’s debt crisis could involve a “selective default” without major consequences.

“(Nowotny) stands in complete agreement with the position of Jean-Claude Trichet and the ECB,” Nowotny’s spokesman said in a statement.

“As clearly said in the CNBC interview, it is about avoiding any option that would make it impossible for the ECB to continue to accept Greek sovereign bonds as collateral.”

It is yet to be seen how the bond markets fully respond to that retraction, but the whole episode just show how utterly unplanned this whole crisis is and the sort of short-term “quick win” mindset that is in place to deal with a problem that is anything but. As the wall street journal reports

Investors remained on edge Tuesday as euro-zone officials attempted to prepare an agreement on private-sector involvement in a new funding package for Greece ahead of a meeting of the currency bloc’s leaders Thursday.

The markets were encouraged early by hints of a compromise between the European Central Bank and euro-zone governments over a second bailout package for Greece, but divisions remained and several options continued to be floated over how to get the private sector to share part of the cost.

A levy on banks, the latest idea being discussed among euro-zone officials, could contribute at least EUR20 billion over the next two to three years to a new aid package, a person familiar with the matter said, but this plan comes with its own set of risks.

Italian and Spanish bonds rose Tuesday after ECB Governing Council member Ewald Nowotny hinted that the ECB may be able to accept some ideas to solve the Greek debt crisis that could include “selective default,” potentially removing a stumbling block that has marred discussions so far and put the euro region’s fate in jeopardy.

“There are some proposals that deal with a very short-lived default situation that would not really have major negative consequences,” Nowotny told CNBC in a recorded interview broadcast Tuesday. “But these are really highly technical aspects.”

However, Nowotny appeared to be backtracking from his earlier comments, with his office later putting out a statement saying he is “in complete agreement with the position represented by ECB President Jean-Claude Trichet,” who has consistently rejected any solution involving even a brief period of default.

Trichet reiterated his position of “no credit event, no selective default, no default,” in an interview published in three newspapers in central and eastern Europe.

Nowotny’s statement acknowledged that “it is important to avoid any constellation that would make it impossible for the ECB to accept Greek government bonds as collateral.”

Politicians want private bondholders to foot a share of the next Greek bailout. But the major rating firms have said the methods proposed thus far would constitute a default, something the ECB has said it is keen to avoid.

Some took Nowotny’s comments as a sign that the ECB may be bending its resistance to at least some options on the table.

“The ECB has lost the battle on avoiding a restructuring or a selective default to the politicians,” said Richard Kelly, head of European rates and foreign-exchange research at TD Securities. “The ECB will have to find a way to provide credit to Greek banks.”

Agreeing on a new aid package for Greece is pivotal to prevent contagion because a further rise in Italian and Spanish bond yields will test the firefighting capabilities of the euro zone’s EUR750 billion bailout facility. Italy is the bloc’s third-largest economy and its government bond market is the largest in the world after the U.S. and Japanese markets.

Despite Nowotny’s apparent backtracking, the yield on the benchmark 10-year Italian bond Tuesday eased further to 5.72%, having surged to a euro-era high of 6.01% on Monday. The yield on the corresponding Spanish bond fell to 6.10% from a euro-era high of 6.33% on Monday.

I have no idea why bond yields are falling because nothing that really matters is actually being addressed. The short term game is still about who will blink first and it is still anyone’s guess, but that is all that will be addressed on Thursday. I personally think the ECB has little choice but to start accepting whatever it takes as collateral because their jawboning doesn’t seem to be cementing any sort of holistic political approach to solving the underlying issues which is what is actually required, in fact it seems to be making those issue worse. But even the ECB strategy is obviously weak and wavering, in their latest bulletin they state that “the ECB’s liquidity support for the banking sector cannot replace the measures that need to be taken by national governments, regulatory bodies and the financial sector itself to ensure the solvency of individual banks.” Realistically, however, that is all bluff the ECB is already holding €2 trillion ($2.8 trillion) worth of Spanish, Portugal, Italy and Greek debt.

It just gets worse for Europe and I can’t for the life of me understand why anyone thinks any differently.

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  1. Here is your answer:

    “it is about avoiding any option that would make it impossible for the ECB to continue to accept Greek sovereign bonds as collateral”

    these guys really do live in fantasy land

  2. The integrity of the financial system is completely shot. These guys spend their time trying to dream up ways to beat their own rules while giving the impression that they are sticking to the rules.

    Let’s assume that Greece gets its bailout and the French and German banks don’t take a haircut. What happens in 12 months time? We arrive at this point and go through the whole charade again.

    I don’t understand why they don’t just default now and be done with it. Or they could just print funny money to pay out the French and German banks and then let Greece go down. Whatever happens, it’s beyond a joke.

  3. They had a nice party ten hours; then two hours about guessing who is going to pay the bill while the last rounds were served. Now the waiter (financial markets) has indicated that he might close down the restaurant soon. He brings up the bill trying to identify the party organizer. All eyes hint him to a women in bad shape and dress. Apparently though this woman pretends that the bill might be shared and that she forgot her checkbook at home.

    Denouement of Galbraiths embezzlement coming to you soon….

  4. MontagueCapulet

    Policy in Europe seems to be based on putting off the inevitable and hoping for a miracle.

  5. Spot on DE.

    I attended a lecture from Marcel von Pfyffer from RBS Morgans today, and he went into the technical side of the EU position which we know is pretty bad, and he thinks both Greece and Italy will default. The bond market will decide what percentage they’ll accept and that will be it.

    He also explained the capital flows out of equities into bonds.

    All in all pretty messy outcome either soon or at some point after the EU kick the can if they can agree on anything.

    • One other thing Marcel said is that they expect some countries to be ejected from the Euro, or more likely it will all fall apart.

  6. MontagueCapulet

    The only thing I can be confident about is that European leaders will put off a solution long enough to guarantee a dramtic crisis.
    If they anounced a split into northern and southern Euro blocks they could head off a crisis now. But they’ll procrastinate until a decision is forced upon them by events. Either the weakest countries leaving EMU one by one as a consequence of default, or the leaders force the ECB to engage in QE despite the illegality of that move and the public opposition.

    • 3d1k that is a cool blog.

      Personally, I can’t see China, Japan, and other institutional bond holders agreeing to a 100% haircut, but I maybe wrong.

      What I can see it them having to accept something less then 100% at some point for certain countries that will never be able to pay back the debt. That is essentially what RBS’s view was today.

      • Yes, eventually it will be accepted that some sort of haircut will have to take place unless the complexity of derivatives makes it too difficult, I’m not sure about that.

  7. I think the most amusing is the Anglosaxon bias as most European countries /EU/Italy even Greece are in better financial shape than US/UK & Euro is so strong it is ridiculous and damaging export.I guess Germany/France would dream to get the Euro to parity with $US.

  8. DE

    Expecting Greece to get out of debt would be more demanding than expecting Tasmania to reduce its share of Australia’s foreign debt without Commonwealth grants and while sharing a monetary system:
    -whose currency is inflated by mineral exports;
    -that produces a two speed economy (from which Tasmania is suffering); and
    – that is continuing to drive the Australian economy deeper into debt.

    Despite our large mineral exports, independent fiscal policy and own currency, Australia is increasing its foreign debt and is experiencing slow economic growth. We could not reduce our foreign debt if we wanted to. What hope has Greece?

    There are fundamental flaws in the Euro monetary system. They are similar to the flaws in our own system.

    The exercise in Europe at this time is to find scapegoats and punish them. You cannot expect the fox to really prevent the chickens from disappearing.

  9. “Australia is increasing its foreign debt and is experiencing slow economic growth.”

    Leigh, I think a closer look will show that net debt has been falling… And slow economic growth? Slow in the parts that had exhausted their growth potential: time for a pause in the property market, time to give the credit cards are well-earned rest, time to leave some cash in the bank where it can rest a while, take up checkers and reflect on past labours…..:)

  10. David

    There were two quarter where net foreign debt were higher than March 2011 $($677B). These were in June 2010 ($686B) and December 2008 ($689B). However, I would not say that there has been a fall. More like a pause. In the last 10 years, net foreign debt and gross foreign debt have more than doubled.

    Over the last 10 years, real GDP per head in Australia has increased at an average rate of 1.3% pa. That is not the growth rate of a booming economy.

  11. The main reason the ECB is unable/unwilling to contemplate default by the sovereigns is very simple. If it were to happen, the ECB itself would instantly become insolvent. So while all concerned might like to pass the losses to the private sector, this cannot be done because the biggest loser will be the ECB. If the ECB were to become insolvent, then the entire banking structure would become inoperable and might not be able to be revived.

    The further problem is that while all kinds of solutions to the EU financial crisis can be identified, hardly any of them are legal within the structure of treaties that define the European system.

    This means that a way has to be found for two things to happen:

    Sovereign debts have to be re-scheduled over very extended terms – say up to 75 years or more – at highly concessional interest rates.

    And the distressed sovereigns have to be kept within the Euro. This means they have to become targets for a meaningfully-large, sustained investment and re-vitalisation efforts.

    The alternative is complete chaos.

    • David

      We already have chaos.

      As I have written before, I doubt that banking can continue in its current form.

      The foreign exchange part of the current banking system is prevented from providing additional money in exchange for foreign reserve assets (because of the floating exchange rate system). Foreign reserves represent current obligations to supply goods.

      However, the lending part of the banking system can issue additional money in return for domestic debt. That debt represents future obligations to supply goods.

      Money represents a current entitlement to goods. So the current banking rules:

      – prevent banks form issuing current entitlements in exchange for current obligations; but

      – they allow banks to issue current entitlements against future obligations.

      This is not a viable and sustainable economic activity. Yet it is a fundamental part of the current monetary system.

      The monetary system is the software that drives the economy’s hardware. These fundamental flaws in the software can only lead to the type of monetary and economic disaster that we are currently experiencing across the world.

      The bankers are the ones who are making the policy decisions. Yet they are the source of the problem. They are not going to change the banking policy for the benefit of the economy if it will mean increased regulation of their lending activities. Countries have to deal with the governance issues before they can deal with the real economic problems.

  12. David

    I dont think dragging out the debt over a longer period of time will make the problem go away…if anything, its the worst of two worlds.

    We would have the ‘chaos’ you so fear as the restructure of that magnitude would = default and the costs of lending would go up anyway…

    Plus…the Greeks would be destined for 20-30 years of debt servitude…they wont stand for it.

    Countries can default. Banks can go bust. Economies can recover

    • Stavros, the interest rates imposed on the Greeks, the Irish and the Portuguese are punitive and unsustainable. They do not have the capacity to pay the 6%pa or so that is expected and it is just pointless insisting they should. They should be given interest rate relief and they should be given extended terms. This will be far far cheaper for everyone than an involuntary or peremptory default.

      There is no doubt that it is might look tempting for the debtor countries to just default. But if they do this unilaterally, since they will not be able to honour their Euro liabilities, it is very probable their own domestic banks will also fail. Every borrower and every depositor will be in jeopardy. Nor will the defaulting governments be able to go to the markets for fresh funding. Of course, the economic contraction that would follow default will mean financial assistance will be really essential, but it will not be available from the markets. The defaulting sovereign will not be able to look to other EU governments for help. They might try the IMF, but they IMF have made it clear nothing can be taken for granted.

      Defaulting is like walking the plank with handcuffs on. It is not a way out. It is a way to the bottom. Furthermore, if a sovereign were to default, not only would the whole network of European banks, insurers, retirement funds and governments be handed losses, all those who lend to or borrow from the EU financial system would also be exposed to losses.

      Default will cause untold financial distress and hardship – and not just in the Euro zone.

      In any case, the sovereigns cannot just walk out of the system. There is no legal mechanism for this to occur. The EU states cannot leave the EMS or the Union.

      They have to find a way to support each other and they have to start by recognising they are all in the same boat, even if they now wish they weren’t.

      • The “untold financial stress and hardship” may be already baked in; just like the climate change guys tell us that the CO2 already released has committed the planet to unavoidable future warming.
        The only question in each case is how much worse we make the long term effects by issuing more debt/CO2.

  13. John Theodorou

    “Three years ago Europe’s and America’s banks were supposed to die in an horrific accident. Their own rampaging greed and corruption had finally caught up with them. But somehow they cheated death. They did it by selling the lives of others; the tax payers in their own nations and those of nations, like Greece and Ireland, whose leaders had long since sold their own rotten and threadbare souls and were now keen to sell the souls of others.

    But Death doesn’t like to be cheated.”

  14. Will the AUD fall as a result of defaults in the EU….? Or will the AUD rise against the Euro due to investors getting out of there?

    I understand why France / Germany would want a weaker Euro to help exports, however will the AUD stand up…