The absolutely final save for Europe, again

It is the day before Europe is saved forever… again … and everyone seems to be getting nervous. Bond yields on the periphery and Belgium are heading back in the wrong direction, with big moves on Spanish paper. CDS reflects similar trends with Spain and Belgium again the big movers.

In the lead up to the October summit it became obvious that there really wasn’t a plan when members of foreign cabinets, the German parliament, the ECB and the German central bank all released press statements contradicting Angela Merkel and each other. In the end Merkel told them all to keep quiet. One wonders why she didn’t learn her lesson and do the same thing this time:

Germany rejected comments by French Prime Minister Francois Fillon that Chancellor Angela Merkel agreed to drop demands on investors to accept losses in any sovereign default, saying that International Monetary Fund rules will ensure private-sector involvement.

“We only made it clear that the kind of PSI you had with Greece is an extreme case that won’t be repeated,” Steffen Seibert, Merkel’s chief spokesman, said by text message late yesterday. So-called collective action clauses “will stay, so the investors will only encounter risks in Europe  that they already know from everywhere else in the world.”

Overnight the Telegraph UK published a letter from Merkozy to the European council president, Herman Van Rompuy, outlining their vision for the economic future of Europe. The things that struck me most about it is the complete lack of anything new and , as I have been saying is needed to make any of this credible,  anything resembling a transition plan.  If simply restating the current plans and listing out ideas that everyone is already aware of is the agenda for the next summit then asset values are in big trouble.

The letter does mention that Europe is going to “foster growth through greater competitiveness as well as greater convergence of economic policies at least amongst Euro Area Member States”. It is anyone’s guess as to what that actually means, but the list of focus areas is quite telling:

  • Financial regulation;
  • Labor markets;
  • Convergence and harmonisation of corporate tax base and creation of a financial transaction tax;
  • Growth supporting policies and more efficient use of European funds in the euro area.

Financial regulation is not new, bringing forward Basel III has been on the table for some time and as we know is having unintended consequences in Eastern Europe. The point about financial regulation does ,however, seem a little ironic given the latest rumour  about the ECB and Invisopower!:

The European Central Bank may announce a range of measures tomorrow to stimulate bank lending, said three euro-area officials with knowledge of policy makers’ deliberations.

Options on the table include loosening collateral criteria so that institutions have more access to cheap ECB cash and offering them longer-term loans to grease the flow of credit to the economy, said the officials, who spoke on condition of anonymity because the discussions are private. Two said an interest rate cut is likely, with only the size of the reduction to be determined for the monthly decision tomorrow.

Labour markets is a given, wages are going to be tied to competitiveness which they always should have been. The reason they didn’t have to be was, once again ironically, mostly because of financial de-regulation. How the transition back is made without destroying the economy is the 4 Trillion Euro question, and it certainly hasn’t been answered yet.

The corporate and transaction tax is interesting. One of the reason Ireland is performing better, at least in a macroeconomic sense, than other periphery nations is because of its competitive corporate tax rate. Any “convergence” of that rate towards other euro nations will see that competitiveness shrink and would damage Ireland’s fragile recovery. In regards to the transaction tax, the UK is not going to be happy. On the back of some further poor economic data this surely going to lead to a showdown with London:

U.K. economic growth slowed in the three months through November, strengthening the case for the Bank of England to loosen monetary policy further, the National Institute of Economic and Social Research said.

Gross domestic product probably rose 0.3 percent, less than the 0.4 percent estimated for the quarter through October, Niesr, whose clients include the Bank of England and the U.K. Treasury, said in an e-mailed statement in London today. Output probably won’t reach its pre-recession peak until 2013, it said.

Growth supporting policies and more efficient use of European funds in the euro area I can only assume means the continuation of austerity policies in the periphery and once again attempting some sort of leveraged private/external/IMF involvement in the existing stability mechanisms. Nothing new there.

As with October’s forum I am starting to sense that the Eurocrats have misunderstood the markets take on the goal of the summit. The letter is completely focussed on implementing policy to move towards a tighter fiscal union but provides no credible framework in which to make that transition. Markets have so far been supportive of the fiscal unification plan but only because they believe it will lead to a relaxing of the reigns on the ECB and it will therefore be allowed “print”. I don’t get the sense that this is the rationale for the Eurocrats, it certainly isn’t present in that letter. It is this divergence of goals that has the potential to lead to a very disappointed market as it did after the last summit.

No wonder everyone is nervous.

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  1. This time, we promise.

    I still think that the Eurocrats are not stupid. They know what they are doing and the plan is of confusion and delay. This causes frustration, loss of attention or sensitivity by the public and media and allows them greater scope to get their way through a political minefield. This is a marathon which can and will last longer than we imagine. If they sat down at a table and said: “hands up those in favor of a fiscal union” it would end very quickly.

    Also they cannot have the appearance of printing. They can not have the bold statement of TARP or LSAP, but will get there in the end. For the survival of the Euro, this must be a gradual process so that their actions are counterbalanced by other nations and the ECB balance sheet is gradually offset by their gold reserves.

    • I doubt they are that sophisticated. Particularly now, since either through inaction, or liability increasing action, they are going to be showered with downgrades.

      There is no easy solution, or solution at all, and the main goal is to somehow stop the collapse happening. They are trying over and over to do something. They aren’t going to roll over and die, even if they know that the situation is much worse than they are prepared to admit publicly.

      The 1% chance, or illusion thereof, is the only thing that keeps them going. But it is just an illusion. Even if it wasn’t, the odds are terribly against them so it’s much better to fold than to go all in.

      • They have a solution: print money, bail out the banks, erode the cost of government debt. They of course cannot front up to the public and say that however, so we have to watch these tiresome charades.

        Think about it, if they were sophisticated and knew how bad the situation was, would they be doing something significantly different? I don’t think so. If they were sophisticated and had vested interests in maintaining the system for as long as possible, clear the debt and know what sort of monetary system that will follow, from their point of view they would not consider ‘folding’ as a desired solution.

        • Printing money is not a solution. It makes things worse, through eventual inflation, moral hazard, and can lead to effective haircuts for bondholders anyway if the bonds aren’t indexed. The resulting inflation that would hit food would devastate the third world.

          Bailing out banks with public money would lead to more debt and instant downgrades. Plus lots of pissed off people. Bond yields would surely spike and force defaults or bailouts. Any EFSF, ESM or other acronym would fail, if it isn’t already failing. What then? Print? Also moral hazard.

          Austerity ensures that countries will keep missing targets. The way Portugal is using pension funds is sick, although Japan has being investing it’s people’s pension funds in bonds for a while anyway so everything must be ok? hehe

          I really think if they were selfless, and sophisticated, they would fold. They would make the choice of a complete union or dissolving it.

          As it stands now they will probably cause downgrades and then when their fundraising fails, they will print.

          • Printing is a solution and will be used 100% of the time in a fiat currency system. Every other debt crisis in history in these circumstances goes along a similar path. The only difference today is that it is happening on a global scale. Printing erodes the debt and eventually the system resets.

            Also note that they never stopped printing. They have been printing frequently and the ECB has been doing more work than the FED under QE2. All this acting directs attention away from this fact and it is working.

            Obviously they are not selfless, but they do seem to be working towards a union which would be a political agenda as opposed to a market solution.

            On the topic of Japan, it seems as though they are running out of their citizens money. Latest bond issues are to be offered with a half ounce gold coin as a gift 😉 I think Japan is next for the headlines after Europe. One at a time they will rotate through Europe, Japan, UK, China, US… fun and games.

          • Not sure what you mean by the system resetting. At least in a massive default, money still has value. If they print debts away, then everyone loses. Bondholder included. I think people are just too silly to learn from the past. Germany’s printing after WW1 didn’t solve anything. Hitler did more for their debt which is a scary thing to say…

            On the topic of Japan, well, it will be crazy when that blows up. As much as I thought that nothing could be done to convince anyone that Europe can be fixed, Japan is truly unfixable. Perhaps if they print themselves into oblivion it would stop most contagion, but the people there.. my heart will break.

          • By the system I mean this monetary paradigm. It isn’t long for this earth. It requires perpetual debt. Money has nominal value right now, but it has no intrinsic value because it has no backing. As things progress this will become clearer. The Euro can actually survive into the next monetary regime as it uses gold in its currency reserves. As the gold value expands it offsets the volume of money that expands to mop up the debt system.

            The printing that caused the rise of Hitler was profligate. This time it is controlled and relatively steady with the intention of financial repression. The end result may be similar, but I believe they have a plan to adjust the money system when the time is right.

    • Macros, I would love to know how their gold reserves are being used in this, and what is the state of that gold wrt counter parties. How much is really there to be used as reserves as such.

      Check this out as well from Business Week. While it’s a political crisis it’s also a debt crisis with little prospects of growth/employment and tighter Basel III requirements.

      I’ll be gobsmacked if the markets are happy with anything they come up with, maybe initially, but what about once they’ve done the numbers.

  2. France and Germany is proposing a scheme where the indebted nations will give up their national sovereignty in exchange for perpetual debt enslavement. Unless the trade imbalance with Germany is reversed, the PIIGS countries are doomed.

    From a macro perspective, the Germans are not spending enough. To solve the EU crisis, the ECB should give every German citizen 10,000 Euro to spend in PIIGS. It’ll be way more effective than buying 1 trillion Euro in PIIGS bonds.

    • The idea is to transfer wealth to banks and bondholders, not the other way around! We can’t have banks losing money on their bonds. Meanwhile, the taxpayers must endure austerity, not handouts! Pfft!

      • I agree. Until bondholders and the big banks are made to suffer their losses, there can be no talk of an end to the crisis. More austerity will merely crush euro economies into dust.

    • To look at that another way, PIIGS don’t make stuff that Germans want at a price they’re willing to pay. They need to reduce the price.

  3. It seems that Merkozy just assume the peripherals will go along with greater fiscal integration. I seriously doubt it.

    As for convergence of corporate tax rates, there is no way Ireland will subscribe to that. If it was put to a referendum, it would fail and if it wasn’t put to a referendum the government in question will be out the door in no time. It would be political suicide.

    I really don’t get what the markets are seeing in all this talk of fiscal integration. It is not going to happen. 17 separate countries effectively agreeing to give up sovereignty to bail out the bank and Germany/France, not a chance.

    It is only a matter of time before one country or other says no thanks, but we will take our chances elsewhere.