Europe descends into farce

Over the weekend it became even more obvious that the new “updated” EFSF  is already failing to meet its defined goals. The G20 proved that the rest of the world doesn’t have the appetite to shovel money at Europe via this sort of mechanism.

World leaders balked at writing new checks to help bail out the euro-area, demanding its own governments first do more to fix the two-year-old debt crisis…“There really are hardly any countries here that said they will join up” with the European Financial Stability Facility, Merkel told reporters.

And why would they ? As I explained previously the EFSF will be a debt issuance mechanism collateralised against European nations that have already been judged unworthy by the markets and then insured , in-part , by the AAA core. The Europeans have spent the last 18 months convincing the world they are politically and economically dysfunctional, so it is no surprise that non-European nations aren’t interested in this “investment”. The latest data out of Germany shows that its economy is slowing considerably and the chart above of Friday’s European services PMI shows the weakness is widespread and accelerating making the structure that the EFSF is supposed to rest on for insurance even more unstable. France is obviously the greatest concern in that regard and I note that they will be announcing their latest austerity budget plans today.

What makes the EFSF look even worse is discussed in the following piece from the Irish news media:

The latest round of issuance by the EFSF has been postponed due to “market conditions”. This is supposed to be an “emergency fund” used to provide liquidity to struggling countries under stressed market conditions. How can anyone trust a stabilising facility that postpones its functions at a time of emergency? And this is an issuance backed by Ireland, a country that has far greater chance of meeting its obligations due to its export position, as the following balance of trade chart demonstrates:

So with the lack of willing external participants, a central bank already baulking at its own balance sheet, a weakening real economy and a stabilisation fund that seems to be struggling with its own mandate who exactly is going to purchase the 1 trillion Euros worth of bonds that the Eurocrats have promised the market? The IMF perhaps?

No… they’re out as well:

A plan to have the International Monetary Fund issue its special currency as a powerful weapon in Europe’s efforts to contain the widening euro-zone debt crisis was blocked by German Chancellor Angela Merkel, according to a report in a German newspaper.

Making the situation even more ridiculous is yet another threat from the ECB to Italy:

The European Central Bank often discusses the possibility ending the purchase of Italian government bonds if it concludes Italy is not adopting promised reforms, ECB Governing Council Member Yves Mersch said.

“If we observe that our interventions are undermined by a lack of efforts by national governments then we have to pose ourselves the problem of the incentive effect,” Mersch said according to extracts of an interview with Italian daily La Stampa to be published on Sunday.

Asked if this meant the ECB would stop buying Italy’s bonds if it did not adopt reforms it has promised to the European Union, Mersch, who heads Luxembourg’s central bank, replied:

“If the ECB board reaches the conclusion that the conditions that led it to take a decision no longer exist, it is free to change that decision at any moment. We discuss this all the time.”

If the ECB actually followed through on this threat then Italian borrowing costs would almost immediately reach a point where it would be required to call on the EFSF. The events of this week have shown that the facility would be unable to provide any meaningful support, and so by removing itself from the Italian bond market the ECB would very quickly find itself under pressure to act once again to save the nation. This threat appears to me to be some sort of hugely naive bluff which does nothing but add to the confusion surrounding Europe’s financial stability.

The bizarre situation surrounding the EFSF can only be matched by the goings-on in the Greek and Italian parliaments.

Last week the Greek Prime Minister , George Papandreou , announced he was calling a public referendum on the latest austerity package as well as a confidence vote for himself. It is still somewhat unknown exactly what he was up to but the general consensus is that it was a somewhat crazed political bluff in order to garner a cabinet mandate to support himself and the austerity package. The weirdest part of the whole thing is that he seemed to have neglected to inform his own party what he was up to, and so in the days following his announcement his finance minister try to undermine him in what looked like a bid for his job and a number of his own party members gave up support for him.

The referendum was later cancelled when the opposition said it would support the austerity package and over the weekend Papandreou narrowly won the vote of confidence but only because he said he promised to work towards forming a unity government and the opposition believed he would go. After all of that the opposition now seems to be returning to its previous position, demanding that Papandreou step aside and demanding elections:

Greek Prime Minister George Papandreou, trying to preserve international aid before the nation runs out of money next month, raced to form a unity government after the opposition’s leader rebuffed his offer yesterday.

Greek President Karolos Papoulias was scheduled to meet with Antonis Samaras, the leader of New Democracy, the biggest opposition party, at 1 p.m. in Athens today to try to persuade him to join a government of national unity. Samaras has so far balked at joining forces with Papandreou’s socialist party even if the premier steps aside and yesterday repeated a demand for elections.

Papandreou’s party and the opposition have now entered their second day of negotiations over the future of the Greek parliament and the formation of a unity government. It is being reported that Panpandreou will resign today to be replaced by Lucas Papademos a former vice president of the ECB who will be given the task of steering the country through the latest bailout package and into new elections. There is obviously much more to play out in this story, but no matter how odd the Greek situation has become it is now being dwarfed by the concern around Italy.

The G20 were obviously unimpressed with Italy’s watered down austerity measures with the IMF president, Christine Lagarde, claiming that they “lacked credibility”. As I mentioned last week, Italy did manage to agree to a limited package of budget reforms but not before Berlusconi and his finance minister once again started throwing insults at each other in the parliament. Even though the cabinet did manage to agree on changes it failed to make them in law, so now each adjustment must go through a confidence vote.

The opposition parties have been meeting with the Italian President to brief him on the situation in an attempt to get him to call early elections and over the weekend they turned out en masse on the streets of Rome to demand Berlusconi’s resignation. But Berlusconi has been defiant and refuses to budge claiming the last election gave him the mandate he needs to continue to lead. It is believed that a group of lawmakers within Berlusconi’s party have struck a deal with the opposition to vote against the government in the forthcoming votes, but it is yet to be seen whether that will give them the number to oust the PM. The first of the confidence votes is this week.

It was reported that Berlusconi repeatedly fell asleep during negotiations at the G20 and that he was embarrassingly forced by Merkel and Sarkozy to ask the IMF to monitor Italy’s fiscal progress. After the meeting Ms Lagarde stated that IMF inspectors will travel to Italy on a quarterly basis and report back on the progress being made. I have no doubt they will be as disappointed by Italy as they were by Greece.

So the Troika is now in visiting the G-8, what a worrying mess Europe has become.

PS: In case anyone would like some background on the IMF’s “special currency” mentioned in this post please see this page from the IMF or the wikipedia page here.

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  1. Thanks DE. The problems as I see them

    (1) The EU/IMF/G20 don’t have the capital to bail out the EU. They know soon Italy, Spain, Portugal will need to be bailed out. If they bail out Greece, what will be left for Italy etc. given the amount of capital they have.

    (2) They want states to implement austerity, yet they claim they’ll also get growth; what planet are they on.

    (3) Take the notion of re-capitalising the IMF by the G20…I’m not sure but they are probably, like Australia, running a CAD so we need to borrow to fix the IMF. So more debt to fix the debt, and no real structural changes…where does that lead.

    (4) One more piece of evidence of which showed me how screwed the EU is came from the request for the Bundesbank to commit its reserves to help fund EFSF. If this is not a huge alarm bell to the market I don’t know what is. I’m not sure if everyone knows, but a large part of Germany’s reserves are physically held in the US. The nature of those reserves given the opaque nature of swaps and leasing is just not known.

    Even with a leveraged EFSF, SDR funding, and what ever monetary magic trick the EU/G20/IMF try, I can’t see how they fix the EU, but what they are likely to do is to create an even bigger problem in the future. More debt, and austerity will fail.

  2. this problem seems insoluble to me, there is no way out but to forgive debt and start again. But that’s not going to happen is it? So where to now?

    • Credit crisis part 2. But first Europe must make all the same mistakes the U.S. did in 2008 – print money. Not to try and just “save” insolvent banks, but entire countries instead.

  3. Greece out of the Euro:
    the scenario accoding to the FT:
    1.The Greek cabinet decides an exit. Rumours begin to circulate. Greek citizens withdraw their euro deposits while they are still euros and not drachmas; supplies of banknotes run short; businesses shift their euro balances abroad. Foreign lenders to Greek businesses cancel credit lines. Banks close their doors.
    2. Following an emergency cabinet meeting, the Greek government announces the new drachma. Capital controls are imposed and border patrols dispatched to enforce them. Public sector debt is redenominated in local currency. The value of the drachma plunges. Greek inflation soars.
    3. Disputes erupt over private sector debt (for example a German bank’s loan to the Greek subsidiary of a multinational such as BMW). Is the obligation still a euro loan or is it now drachma-denominated? If it is a drachma loan then the German bank has a problem – a drachma asset worth a fraction of its euro book value. If, on the other hand, the obligation remains in euros then both bank and company have a problem as the Greek borrower now has a euro loan which it must service from depreciating drachma income.
    4. Contagion commences. Portuguese citizens worry that it might happen there. Portuguese depositors begin to withdraw euros for fear they will soon be escudos. Companies in Portugal transfer funds abroad as a precaution. Banks close. Soon, similar scenes occur in Ireland with echoes elsewhere along the Mediterranean. Banks cease dealings with their “peripheral” counterparts.
    5. Confusion mounts over the magnitude of European bank exposure to the private sector of the periphery. Trading with and between Europe’s banks stops. Bank stocks crater and haven assets rise. In response to an inward flood of capital Switzerland imposes punitive negative interest rates on non-resident deposits.
    6. Bank lending across the EU ceases. Economic activity halts.