Europe prepares for breakup

Overnight Angela Merkel addressed her party congress calling for an overhaul of the European Union:

German Chancellor Angela Merkel called for an overhaul of the European Union, advocating closer political ties and tighter budget rules, in her most explicit prescription for ending the debt crisis.

Speaking to her Christian Democratic Union party’s annual congress in the eastern German city of Leipzig today, Merkel said leaders must create a “new Europe” by deepening ties in the 27-nation EU. At the same time, she repeated Germany’s rejection of jointly sold euro bonds.

“The task of our generation now is to complete the economic and currency union in Europe and, step by step, create a political union,” Merkel said. “It’s time for a breakthrough to a new Europe.”

CDU delegates also voted and approved a motion to permit euro nations to exit the currency without exclusion from the European Union, however they they rejected an amendment to change the voting rights at the European Central Bank so that it is corresponded to the size of each nations economies.

This was obviously a political message aimed at her own country, European nations and the markets, but it does seem to support the rumours that Europe is heading for an overhaul with the introduction of a two-speed Europe that would involve establishing a more integrated and potentially smaller euro-zone.  Obviously it is still early days but it is hard to deny, at least in my mind, that the evidence is mounting that this is the new goal. The introduction of an “opt-out” clause for the euro is a huge step in that direction and appears to fit well with recent comments made by Sarkozy. What does it mean in a practical sense? Who knows ? But it is obviously a gigantic shift for Europe and I am not sure the markets are prepared for what it could entail. Obviously I will be watching.

In the meantime, Europe in its current form continues to flounder:

Portugal’s gross domestic product fell 0.4 per cent in the third quarter from the second, data showed today, as the country’s recession deepened under the weight of sweeping austerity.

The National Statistics Institute’s (INE) flash GDP estimate showed a decline of 1.7 per cent year-on-year, with consumption and investment slumping.

In the second quarter, GDP posted a revised decline of 0.1 percent from the previous quarter and slumped 1.0 per cent year-on-year. The initial readings were zero and 0.9 per cent, respectively.

Portugal slid into recession in the first quarter of this year after growing 1.4 per cent for the whole of 2010.

In Italy, Prime Minister-designate Mario Monti began talks to create a new government of non-political experts as a letter has appeared outlining Italy’s plans for austerity including plans to cut 300,000 public-sector jobs by 2014, raise the pension age and cap the amount of debt local governments can carry. There have also been a number of reports circling stating that the ECB held back on bond purchases last week in order to apply pressure to Berlusconi to leave office. The ECB seems to have been back on board last night with Italy managing to sell  €3 billion of five-year bonds at an average yield of 6.29%. Not a good outcome by any stretch and equities sold off on the result, but it was better than a failed auction which is incidentally what Slovakia managed. To top Italy’s bad run UniCredit, the country’s largest retail bank, reported a massive €10.6 billion third quarter loss.

In Greece the path out of the economic mess is as murky as ever. The fact that it took 4 days to select a new government probably should have been a warning that political agreement would be fleeting. Overnight it looks as though the politicking over the bailout has begun once again:

…. the leader of Greece’s main conservative group Antonis Samaras said on Monday his New Democracy party would not vote for any new austerity measures and said the mix of policies demanded by international lenders should be changed.

“We will not vote for any new measures,” Samaras told a meeting of his own MPs.

He added that he would not sign any letter pledging a commitment to austerity measures, as has been demanded by EU Economic and Monetary Affairs Commissioner Olli Rehn, and that a verbal pledge should be sufficient.

Rehn has said the EU and IMF will not release the tranche without written assurances from all Greek parties that they will back the measures.

Another story to watch closely.

Finally, Eurostat released European industrial production figures last night and the headline number weren’t too good:

European industrial production declined the most in 2 1/2 years in September, led by capital and consumer goods, as the sovereign-debt crisis pushed the economy toward a recession.

Production in the 17-nation euro area dropped 2 percent from August, when it rose 1.4 percent, the European Union’s statistics office in Luxembourg said today. Economists had forecast a drop of 2.3 percent, according to the median of 35 estimates in a Bloomberg News survey. From a year earlier, September production increased 2.2 percent.

Although the YoY figure still shows growth the chart appears to show that production growth has stalled and is heading for a roll-over:

Big changes coming to Europe ? Maybe….. but not before a crappy economic winter.

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  1. The new Greek PM says that EU/Euro is the only place for Greece, so Germany better be prepared for an ongoing transfer union I guess. Who knows what’s going to happen, but the way bond auctions are playing out it’s not looking good. There must be a point where the ECB will be unable to keep buying bonds as well IMO.

    So “Big changes coming to Europe ? Maybe….. but not before a crappy economic winter.” most likely.

  2. this all sounds like good news to me. eu finally realising it has some serious problems that need structural reform.

    “reports circling that the ECB held back on bond purchases last week in order to apply pressure to Berlusconi to leave office”

    exactly what i said here last week.

      • not ideal but these crooks have been hiding behind eu genourosity for long enough and where has it got us? personally im sick of douch bags like bunga bunga and karamanlis not appreciaiting that their incompetence has ramifications for all of us.

  3. The Euro and EU will be gone before it is all said and done. Everyone will resort back to their own currencies etc…. that is what I believe will happen

    • We can only hope so. It will be better for the nations involved to regain control of their own currencies, which can automatically adjust to the differences between each nation.

    • LBS was thinking about this and here is an analogy for you. when they first invented the car it went pretty well on flat ground. the first time it encountered rough conditions it snapped an axel. did they “revert” back to horse and cart or did they put the car back in the workshop and improve what was clearly a big leap forward?

      • No, I think it is more like they decided to build a car with a steering wheel for each passenger, each of whom whom want to go off in a different direction, then wondering why the thing doesn’t drive straight. They need to give each of the passengers their own car back.

        • My exact point Hamish. EU is a disaster and the leaders are starting to realize it. @GB it might be longer but the EU will break eventually doesnt make sense for another country to control a currency for another one. Its a train wreck waiting to happen which has just started.

      • If the Euro can be likened to a car, it would be in the sense that it has a driver’s seat, but no-one in it. It has a set of brakes, a simple throttle, but no gear box. It has a fuel tank, but this is not properly connected to the engine, which in any case has only a crank-style starter-motor. It is built more for intermittent, stationery power than for cruising. It has been intentionally designed to produce very limited output to serve as a prototype. It needs a lot of work.

      • im not an equity permabull. my advice, based on recent history, is take anything veliciraptor says and multiply it minus 1 and you will be on the right track.

  4. What’s funny is that politicians, technocrats and the naive who support them, still believe that they can influence the markets. If the past few years is any indication, the market is preparing to throw them and their countries under the proverbial bus for this hubris!

      • They cannot print, strictly speaking. It is contrary to the law establishing the Euro and the ECB. They have done a bit of printing, but really they cannot go far without infringing the law. It has to be taken as extremely unlikely that they will knowingly, consciously and publicly print on a large scale.

        • “They cannot print…”

          Yet equity and commodities markets, if you go by price action, are convinced it’s going to occur.

          We’ll soon find out, I guess.

  5. Does anyone think a fiscal and political union is possible, outside Germany, France, Holland and Belgium?

    GB, you’re a Euro-optimist, can you see any of the PIIGS becoming part of a fiscal union?

    • Lorax – the nations would either need to come under one political umbrella, or revert back to their own currency.

    • Resounding YES.

      The austerity measures imposed now are not a misguided tool to correct economic woes. European leaders aren’t that stupid. (I think it’s pretty naive to think those people are up there despite a lack of knowledge about such things.)

      What you see is Europe using the political opportunity to bring memberstates in line with other EU memberstates which is needed to establish a political and fiscal Union. That’s my interpretation anyway.

      Stimulation of economies would be fantastic but:
      a) there’s no money for it.
      b) it would waste a once in 50 years opportunity to get a breakthrough. How else can you consolidate a 15 year difference in pension age? It’s hard enough now, impossible without a crisis.

      Political Union will not happen tomorrow but the EU’s history and construction is one of (sometimes forced) incrementalism. It has often been ugly but it has always been successful.

      Fantastic and mandatory read for anyone interested in the EU:

      It’s an oldie so you’ll miss out on the Lisbon Treaty and such but still offers a great insight.

      • AnonNL:

        The austerity measures imposed now are not a misguided tool to correct economic woes

        I struggle to understand how austerity will help Greece, Spain, Italy or Portugal. Their economies are too far gone, and desperately need a boost to their competitiveness, which IMO, can only come from a currency devaluation.

        What you see is Europe using the political opportunity to bring memberstates in line with other EU memberstates…

        Fair enough, and I think there’s a chance this can work in Germany, France, Holland, Belgium, Austria and a few other smaller states.

        But how can it possibly work for the likes of Greece?

        Political Union will not happen tomorrow…

        The problem is, things are moving too fast now. The PIIGS economies are crashing, and government bond yields exploding.

        Europe needed to act decisively 12-18 months ago. Its too late now.

      • >European leaders aren’t that stupid.

        Well I would hope that is the case, however there is some pretty good evidence that it is not.

        The recently leaked ‘troika report’ demonstrates pretty clearly that the outcomes of Greece were a complete surprise to everyone involved, even though it was obvious from the outset what austerity on that scale would do to a highly indebted nation with a trade imbalance of that magnitude.

      • The Greek retirement age is greater than the German. The austerity is being pursued because the half-witted currency/banking system will not allow any other mode of adjustment in the deficit economies.

        Talk of fiscal union is just fanciful. This will require a whole new round of treaty development and ratification – an impossible ask in the time available.

        The French are trying to protect their own budget and credit rating, as are the Germans. They are also intent on trying to protect their respective banking industries, who are at risk of failing but cannot be re-capitalised by the public sector – the debts are too large. All in all, the financial sector in Europe is about 4-times larger than European GDP.

        This is a bubble in the process of deflation and the weaker economies are meeting the costs. The Germans and French hope they will be able to weather the storm and will fight to defend the Euro in order to protect the solvency of their own finance sectors.

        This is madness, but sometimes the only sane options were locked out of the room.

    • im not an euro optimist as such just not a euro pesimist. i think they will work it out but your question is where this whole euro thing lives or dies.

      after 10 years they have gone as far as they can with monetary union alone. most people in europe actually preffer the euro to their previous currencies even the greeks.

      they now need to take the next step wich involves some sort of of fiscal union as everyone now understands the limitations of monetary union alone. will they / wont they take that step? but its either they step forward into some sort of transitory fiscal union or step back to where they were before the euro are the only 2 options. the current staus quo is just not going to work as we are seeing all to clearly now.

      i think they will step forward rather than back though is how it will play out in the end. but thats a very long way off.

      • Indeed, even in The Netherlands only 32% of people want to return to the Guilder despite all what is going on at the moment.

        I agree with GB. Europe rather steps forward than loosing all what has been gained. The last two years, no matter how ugly have proven that (to me anyway).

    • Does anyone think a fiscal and political union is possible, outside Germany, France, Holland and Belgium?

      Most definately.

      If the PIGS take out French banks, I would not be surprised to see Germany leave the French to fend for themselves.

      Germany would perhaps consider to form a new currency union with a smaller group, with all members it can brow beat. More similar to themselves culturally and economically.

      Consisting of Germany with Austria, Finland & Sweden, with a high chance of the the Czech Republic and the Baltic states (who Germany can afford to bail out comlpetely) and a lesser chance of the Netherlands and Poland.

      Then you’ll have a two-speed Europe seperated by the Rhine, with a legacy of two world wars, trade barriers won’t be so fast to arise.

      Thus the east of the rhine will export inflation to France and the PIIGS

    • I agree with AnonNL assessment. This is a perfect opportunity to consolidate things that would otherwise be almost impossible to achieve.
      A crisis always brings about changes and people are more like to agree on things now than they would during less stressful times.

      I think in the end all of the PIIGS will agree to a much tighter political and governmental union, although some of them may transition there more slowly than others and some may default beforehand.

      Reality was always going to catch up in the end. It may be easier to adapt when you have others to assist you transition than when you are on your own.
      In the long run the EU will be stronger for all of this.

  6. How did you get from:

    “The task of our generation now is to complete the economic and currency union in Europe and, step by step, create a political union,” Merkel said. “It’s time for a breakthrough to a new Europe.”


    “Europe prepares for breakup”

    It baffles me. The Eurozone is not Europe, nor is it the EU.

    • “It baffles me. The Eurozone is not Europe, nor is it the EU.”

      But the Eurocrats and politicians seem to have hitched the one with other, otherwise they could have let Greece slip out of the EMU last year, when costs could have been possibly contained.

      Now they have, at least publicly, sworn to go down together. When the Eurozone collapses for many members this will spell the end of closer political union, perhaps for several generations. Besides, they will probably have 30 years of domestic fallout dealing with economic collapse, to have time to entertain such lofty aims again, any time soon.

      Especially if the Eurocrats, politicians and technocrats have it in mind to throw entire nations under the bus, as they seem prepared to, in order to salvage the un-salvageable status quo and the too big to fail banking system.

  7. Why doesn’t Germany leave the Euro (maybe with Finland & Netherlands, et al). Then the Euro can be devalued so that the PIGS et al can become competitive.

    • I mentioned that above.

      However, if anyone can inform me of the folowing, it was from the last episode of SBS’ insight about the greek crisis.

      <i.OLIVER MARC HARTWICH, ECONOMIST: You have to realise that the euro was a political project from the very beginning – it was the result of a power play between France and Germany in 1990. The French insisted that the Germans give up their currency as a price for unification</b? and they created this euro currency, a political project, it was meant to further the process of European integration but unfortunately European countries at that stage were still quite different…

      Transcript here

      Can anyone inform me how France could ‘insist’ on this sort of condition for unification?

      • Yes, the Euro was/is a political project with the goal of furthering the European Integration, definitely. And yes, in the process that goal was considered important enough to take the risk of having to face what is happening now. Some would even say that it was done EXACTLY to put Europe where it is now, thus forcing further steps to political Union…

        However, I do not see how this can be interpreted as France forcing Germany to abandon their currency. Germany has been a strong proponent of European integration, perhaps partly because of a national guilt which does seem to exist after what happened in WW2.

    • The point really is that if the Euro is no longer going to be the currency of the powerful states (or even of a significant share of weaker states), the banking system will immediately be in limbo. What would it mean for the valuation of the Euro assets and liabilities if the Euro were no longer going to be in use in Germany? What use would the ECB have if it were no longer being guaranteed by Germany?

      This is the greatest monetary stuff up of all time and it is being compounded by the peaking of the greatest bubble of all time.

      What were they thinking when they created this!! And what were they doing while they were supposedly managing this insane system???

  8. Jim Millstein is chairman of Millstein & Co. He most recently served as chief restructuring officer at the US Treasury, where he led the rescue of AIG. Millstein was previously global co-head of restructuring at Lazard .

    He says::
    The financial fates of Europe’s banks and its governments are inextricably linked: because the banks are the primary source of funding for government deficits, government debt represents a large proportion of the asset base of most eurozone banks. Insolvency of one therefore threatens insolvency of the other.
    The prevailing narrative is that this symbiosis makes the largest European banks too big to fail, driving eurozone governments to provide massive capital infusions and guarantees to banks during financial crises. The truth, however, is that, given the level of eurozone government indebtedness and the relative size of Europe’s banks, Europe’s largest banks are now too big to save.
    The now inevitable restructuring of eurozone government debt will result in bank capital deficiencies which the International Monetary Fund estimates could exceed €300bn. European taxpayers cannot afford to cover this bill: tapping already thin public coffers will mean higher sovereign borrowing costs and dimmer prospects for growth. Even the strongest European economies now face this constraint.
    Ultimately European governments will have to abandon their implicit guarantees for banks to protect their own solvency.
    Equally, in the short term, governments cannot walk away from support for the banking sector without putting their own immediate funding needs at risk and potentially triggering the collapse of private credit formation in the eurozone with disastrous effects on the real economy.
    These are the unfortunate facts: a number of governments will need to restructure their debts to bring them to a sustainable level; as a result, banks are going to need significant capital to absorb those losses; and, given the high level of government indebtedness across the eurozone as a whole, new sources of private funding need to be found to cover those losses to get out of the death spiral of interdependency that eurozone governments and banks now find themselves in.
    First, there needs to be an honest sizing of the problem, identifying those sovereigns whose current debt levels are hopelessly unsustainable as well as the level of debt relief required to restore sustainability.
    Second, the European Banking Authority (EBA) must implement stress tests that take into account the identified need for writedowns of sovereign debt and the consequent bank capital that needs to be raised.
    Third, the EBA should provide a deadline for affected firms to make up shortfalls from private markets or out of retained earnings.
    Fourth, a federal financing body, such as the European Investment Bank (EIB), must provide a capital backstop should identified shortfalls fail to be met from private sources. To give it the firepower it needs for the size of the problem, the EIB must be empowered to raise debt supported by a stream of new tax revenues dedicated to retire the debt incurred.
    Fifth, because the death spiral of interdependency makes further tapping of general tax revenues counterproductive, and collective credit support – such as through a leveraged European financial stability facility, the eurozone’s bail-out fund – is constrained by the over-indebtedness of the member nations, the EIB’s capital backstop should be funded through a new federal tax on bank salaries and profits above defined levels.
    Neutralising the long-term threat to financial stability of too big to save banks, however, will require a separate antidote. Using France as an example, assets at its five largest banks are over three times the size of the French economy. The disorderly failure of any one of them could cripple credit markets, not just in France, but throughout the eurozone. Yet France can no longer afford to save any one of them on its own.
    Therefore, policymakers need to take a play from the antitrust handbook and break up any firm that is too big to save, thus removing a common threat to fiscal accounts and financial stability.
    The one inescapable conclusion we must all draw from the recent financial crisis is that the so-called “global systemically important financial institutions” are not only too big to fail and too big to save, but most importantly, they are also too big to manage. The risks they run are too complex for the small group of managers at the top of any one of these mammoth organisations to fully grasp, for regulators to supervise and for investors to understand and discipline.
    In the US, the Dodd-Frank act provides regulators with the authority to break up banks with more than $50bn in total consolidated assets that pose a threat to financial stability. Europe needs comparable authority. And regulators on both sides of the Atlantic must have the courage to exercise it.

    • rosencrantz, anyone that “led the rescue of AIG” should be thrown in jail rather than looked up to. that comapny singlehandedly took the world and the US taxpayer to the brink of economic collapse. had AIG gone under we would have had a proper investigation into what caused the GFC, as it happened AIG and other parasitic entities got bialed out so we never got to have a look at what got swept under the rug. bailing out the likes of AIG is akin to perverting the course of justice as all would have been revealed but wasnt. your post doesnt make any sense anyway. on one hand you say we should look up to co-conspiators like millstein for his heroic “rescue” (with taxpayer money mind you, not his own!)of AIG but on the other hand you say “break up any firm that is too big to save”

      so what is it? bail out or break up?

    • “The now inevitable restructuring of eurozone government debt will result in bank capital deficiencies which the International Monetary Fund estimates could exceed €300bn. European taxpayers cannot afford to cover this bill: tapping already thin public coffers will mean higher sovereign borrowing costs and dimmer prospects for growth.”

      If only the amount could be limited to Eu300 billion, the Germans would write a cheque today.

      The true proportions are much greater. The European financial system – not including the UK – has assets around EU 40 trillion. If even 5% of this becomes impaired as a result of sovereign default or private sector contraction,the system will have a deficiency of Eu 2 trillion. This is to take no account of the (unquantifiable) liabilities in the CDS markets. The losses buried in the Euro financial system could be many times greater this.

      Compared to the dimensions of the problem, the suffering so far of Greek, Spanish, Portuguese, Slovenian, Slovakian, Hungarian, Irish and Italian workers looks quite modest.

  9. We can all hope for a good outcome in Europe, but all the signs are that this is going badly.

    No the EU commissioner is considering suspending ratings “The EU will propose suspending the credit ratings of countries receiving international bailouts or if the ratings cause market instability, markets commissioner Michel Barnier said Monday.”. Ok so this is not going to stop the markets thinking other than this is “worse” than we suspected.

    The ECB and the IMF don’t have enough money to bail out Italy so all those other states that are on the brink are going to make matters worse. If they had the capability there would have been action by now…the EU is not mad, they are broke … EOM.

  10. Can you imagine what would happen if Greece tomorrow said it was exiting the euro and returning to the drachma? There would basically be a run on Greece. There would effectively be no capital left in Greece. The drachma would be worthless. European banks would have to write Greek debt virtually to zero. While the Financial sector would survive this, you still have the contagion issue.

    I like the principle of default or euro exit for debt relief and a ‘clean slate’. But surely the only plausible reason why this hasn’t been done already is because the adjustment would bankrupt the financial sector? It could be another Depression. The leverage that has built up in the financial system over the past two or three decades simply can’t handle a Europen sovereign default.

    • “The leverage that has built up in the financial system over the past two or three decades simply can’t handle a Europen sovereign default.”

      But it’s still going to happen. That’s what you get when people believe there’s such a thing as a “free lunch” (i.e. thinking you can eliminate all risk, with no money down).

      Welcome to the transcendental object at the end of time.

  11. In Europe deflation seems to be the near term issue even if they do print some amount under the enormous pressure from markets. However, I doubt the Germans would allow the kind of printing that the markets are expecting and somewhat pricing in at the moment.
    There’s a long way to go before Europeans from various countries would be comfortable with the term “state” which is so casually thrown around, even if they do like the sound of a fiscal union amidst this mess.

    I suspect that the euro zone will eventually break.

    If the weaker ones did return to their own currencies, there would have to be some sort of debt jubilee or some serious stimulus on offer for them because paying off euro nominated enormous debt would be impossible.
    If they got the weak Euro and the northern countries went back to their own currencies like someone mentioned, it would be a choice hard to swallow for the stronger counterparts and the creditors I suspect. What would that mean for the banks?

    Does anyone know if it is a valid fact that it is possible to QE indefinite amounts and expect a controlled outcome? Or would that be the greatest financial experiment of our time?

  12. There is just one way to fix this – orderly exit form the Euro zine of the debtor economies with ongoing financial support, probably by the IMF for these economies, and for the ECB to buy (print) impaired sovereign debt so that the banks remain solvent, whole the strong economies exercise fiscal expansion, generating system-wide demand.

    Anything less than this will not work (though more than this may well be required as well).

    • “…orderly exit form the Euro zine…”

      I hear this argument all the time, except has there ever been such a thing as an orderly default? Seems like more wishful thinking. When the stampede for the exits begins, almost everyone will get creamed as the vast majority (the herd) are wrong both at the tops and bottoms.

        • This Ponzi scheme will unravel as all such schemes do – suddenly. There won’t be time to devise anything. Besides, after 14 meetings in 12 months or so, what did the EU achieve except to fill the markets full of empty promises, a gambit which is quickly wearing thin. I read that Italian 10yr bonds are back above 7% and French yields are at all time highs too. So much for the X-Men factor.