Europe’s end game


Last week there was a hint that the Europeans may have been finally grasping at a real resolution to their long running economic crisis. The speed at which the EFSF guarantee of the smaller periphery nations had led to contagion in Italy and Spain came as a surprise to the Euro-elite and under pressure from the market it seemed that we were about to see something more permanent and enduring.

The pressure on Europe to resolve its issues was highlight by a British think-tank on Friday with its prognosis that Italy will inevitably default while Spain may just scrape through.

Debt-laden Italy is likely to default, but Spain might just avoid it, according to the British think tank, the Centre for Economics and Business Research.

With the countries weighed down by debt, the think tank modelled “good” and “bad” economic scenarios for both.

It found that Italy will not avoid default unless it sees an unlikely big jump in economic growth. However, it said, “there is a real chance that Spain may avoid default”.

Even though Italy has managed to run tight budgets, and has vowed to eliminate its deficit by 2014, the economy needs a significant boost in growth.

But its economy grew by just 0.1% in the first quarter of 2011 and further growth is expected to remain sluggish.

On Wednesday, Italian Prime Minister Silvio Berlusconi addressed parliament, saying the economy was “strong” and the nation’s banks “solvent”.

But many economists believe that the eurozone’s third largest economy risks being engulfed in the debt crisis. In a report published on Thursday, the CEBR calculated that Italy’s debt would rise from 128% of annual output to 150% by 2017 if bond yields stay above the current 6% and growth remains stagnant.

“Even if the cost of borrowing goes back down to 4%, the growth rate is so anaemic that we see the debt-GDP ratio remaining at 123% in 2018,” said Doug McWilliams, the CEBR’s chief executive.

The conditions in Spain are better because its debt is much lower. Even under the “bad” scenario, Madrid’s debt ratio would climb to no higher than 75% of national output.

“Fingers crossed but there is a real chance that Spain may avoid default and debt restructuring, unless it gets dragged down by contagion,” Mr McWilliams said.


I’m not going to analyse these predictions as it is now seems a moot point, but I do wonder how anyone could be proclaiming that Spain will somehow avoid financial contagion if Italy defaulted.

Under the mounting pressure from the markets the European Commission President José Manuel Barroso asked the Euro-elite to consider expanding the EFSF so that it was also available to the larger economies of Italy and Spain. At the same time the ECB started buying government bonds of troubled nations in an attempt to provide some stability to their funding costs.

These may seem like desperate measures, and they are, but they are measures that are required because once again we were seeing a total lack of decisive leadership from the European politicians and policy makers. At the last crisis meeting, the expansion of the EFSF to a size that could have potentially matched the needs of all the PIIGS was knocked back by the German and Finnish representatives who stated that they first wanted to see more austerity measure introduced by EFSF recipients. Given that these same people have witnessed Greece return to the begging bowl twice under terms of austerity, I wonder exactly why they expect a different outcome for other nations. But this simply highlights the fact that the Euro-elite continue to ignore the dynamics of the macro-economic mess they have created which is only adding to the problems created by their own indecision.


The lack of comprehensive response has allowed the markets to hold Italy and Spain at ransom, which has meant that once again Europe has needed to call a crisis meeting to find yet another solution. I have stated a number of times that Europe has two choices. A comprehensive fiscal and monetary union or a break-up. The EFSF seems to be a step on the path to a union. It was the beginnings of a treasury (when you are not having a treasury) and at least looked as if we were going to see an issuance of a Euro-bond where all nations accepted responsibility for each others debt under something that looked like an intra-European IMF.

This weekend however there seems to be the potential for all that to have changed. On Saturday Dow Jones News wires released the following.

Germany’s government thinks Italy is too big for Europe’s rescue fund to save, Der Spiegel magazine reports in a preview of an article to be published Monday.

The government doubts whether even tripling the size of the rescue fund, known as the European Financial Stability Facility, would enable it to save Italy because the country’s financing needs are so enormous, the magazine reports without naming the source of its information.

European Commission President Jose Manuel Barroso this week suggested increasing the size of the EFSF, which currently has a planned lending capacity of EUR440 billion ($622.9 billion), to help stem Europe’s worsening debt crisis.

German government finance experts believe euro-zone states couldn’t guarantee Italy’s EUR1.8 trillion of sovereign debt without markets considering Germany to be overstretched, Der Spiegel reports.

Germany’s government therefore insists that Italy push through savings and reforms to help it exit the crisis, the magazine reports. It thinks the EFSF should only be used to rescue small and mid-size countries, the magazine reports.


I covered last week what austerity will mean for Italy, it most certainly is not a solution. Without considerable time to deal with its productivity and competitiveness, austerity will be counterproductive and inevitably lead to default without considerable external support.

German resistance to support is not new and may, of course, be horse trading. But, then again, if we consider what it would mean to Germany to expand the EFSF in support of Italy, the resistance doesn’t look all that irrational. If the EFSF is expanded by €1.5 trillion to support both Italy and Spain then Germany would have EFSF obligations of €790 billion or 32% of German GDP. If, as I suspect will occur under the current circumstances, France also joins in then Germany will own 90% of the obligations or 56% of its GDP.

But if Europe is unwilling to provide such support then it is very unlikely to come from other nations. So without some form of additional intra-European obligation it is doubtful we will see any resolution. On Sunday we saw every level of crisis meeting after crisis meeting as the world’s leader once again clamber for a fix.


Global policymakers held an emergency conference call on Sunday to discuss the twin debt crises in Europe and the United States that are causing market turmoil and stoking fears of the rich world sliding back into recession.

After a week that saw $2.5 trillion wiped off global stock markets, political leaders are under mounting pressure to reassure investors that Western governments have both the will and ability to reduce their huge and growing public debt loads.

South Korea said finance deputies from the Group of 20 major economies discussed the European debt crisis and U.S. sovereign rating downgrade on Sunday morning in Asian time zones.

A Japanese government source said finance leaders from the Group of Seven big developed economies would also discuss the crisis and may issue a statement afterwards, although the timing of such a call was unclear.

The European Central Bank was scheduled to hold a rare Sunday afternoon conference call. Investors are anxiously looking for the central bank to start buying Italian and Spanish debt on Monday to stabilize prices, a move that has split the ECB governing council.

French President Nicolas Sarkozy, who chairs the G7/G20 group of leading economies, conferred with Britain’s Prime Minister David Cameron on Saturday.

But realistically it doesn’t matter what the G7 or the G20 do. If Germany refuses to support the purchase of Italian and Spanish bonds by the ECB, or the expansion of the EFSF, along with that continuing support over many years, then Italy will default.

The most immediate concern for financial markets was the debt crisis in the euro zone, where yields on Italian and Spanish debt have soared to 14-year highs on political wrangling and doubts over the vigour of budget cuts.

Investors saw the ECB’s failure to include Italy and Spain in a relaunch of its bond purchases late last week as a sign of the depth of political divisions over the role of the euro zone currency.

German officials want to see stiffer austerity programmes in place before the ECB would shoulder more Italian and Spanish debt.

The danger is that further pressure on Italian and Spanish bonds could undermine an already damaged European banking system and lock Italy, the world’s eighth largest economy, out of the market.

Indeed, doubts are growing in the German government that Italy could be rescued by the European emergency fund, even if the fund were tripled in size, according to the German news magazine Der Spiegel.

The financial needs of the country are so huge that it would overwhelm resources, according to government experts, Der Spiegel said in its online edition. Italy’s public debt is about 1.8 trillion euros, or 120 percent of its national output.


I find it hard to believe that given the interdependencies that Germany will allow Europe to fail. I cannot understate just how big of an economic event this would be. We are talking Lehman on steroids. If Italy defaults, then it is likely that every other periphery nation would follow suit, followed by France along with the entire European banking system. In comparison the S&P downgrade of US debt would be a teddy bear’s picnic.

Although I dare not consider that outcome it is becoming increasingly difficult to consider any others. I have been covering this crisis for nearly 16 months and in that time I have not witnessed a single decision that suggests any of the European leaders have the political will to consider the needs of Europe over the needs of their own nations. Previous crisis meetings have always become bogged down in the politics of nations, instead of concentrating on strategies to ensure the economic future of Europe as a whole. I therefore find it very difficult to believe that we will suddenly witness the sort of leadership that is required to solve this crisis permanently. Unfortunately this time it looks like that is exactly what is required.