Week in Review Part I: Europe, Washington and Wall Street

When we last left off, European leaders, sans Britain, were busily putting the final touches on the fiscal “compact” designed to enshrine tough budget rules and penalties for profligate spenders. The full details are to be worked out over the coming weeks and months in time for a summit in March, with ratification by all members of the EU, or at least the euro-17, by June but, already, there are growing questions in various capitals, such as what happens to each nation’s tax policies, or the financial transactions tax that upset Britain so much?

Given whatever the details are, the Irish, for example, may be under pressure to hold a referendum that the government would struggle to win. Parliaments in Slovakia (which has the euro) and the Czech Republic (which doesn’t) may turn the compact down. Finland is balking again over bailouts of other EU members and use of the European Stability Mechanism (ESM). France’s leading presidential contender insists on Eurobonds. And as The Economist editorializes, “there are murmurs that Germany, which has benefited so handsomely from the euro, is asking too much of everybody else.”

All this while the bank funding crisis continues, despite the European Central Bank’s maneuvering and offer of cheap money for three years. The stresses on the financial system haven’t gone away and in some cases, such as with small business, have only gotten worse as banks pull back from lending even further.
And I hate to beat a dead horse, but here’s the bottom line. We’re still in a situation where we seem to be living auction to auction and, again, the eurozone’s banks and sovereigns need to roll over some 2 trillion euro in debt next year, 590 billion between Italy and Spain (925 billion over 2012-2013) and, thus far, ECB efforts to hold down rates have been largely ineffective. True, Spain’s 10-year yielded around 5.35% by week’s end, which isn’t a disaster, but Italy’s was back over 7.00% at one point and finished at 6.55%, hardly sustainable.

Plus, the new treaty being worked on does absolutely nothing in terms of increasing the size of the bailout pools, or firewalls, either through the ESM or European Financial Stability Facility, EFSF. All the compact did was raise 200 billion euro for the IMF which is peanuts given the potential exposures.
So we’ll just continue to lurch from crisis to crisis, good weeks followed by not so good ones, with the U.S. and Asian economies, broadly speaking, held hostage. Is this any way to run a planet?

It’s also rather important that there’s no growth in Europe. Standard Chartered Bank forecasts the eurozone GDP will fall 1.2% in 2012. The eurozone’s manufacturing index for December came in at 46.9, a fourth straight month of contraction. Leading companies like Volkswagen AG said they’ve turned “more cautious” on 2012. Ireland, in reporting its economy shrunk in the third quarter by 1.9%, is heading back into recession. The new technocrat Italian government of Mario Monti may have received a vote of confidence for its austerity moves, but there is no actual reform. And when it comes to the nation where this whole mess all started, Greece, their contraction this year is going to be worse than expected, down 5.5%.

Then there are the Brits, who with Prime Minister Cameron’s pullout at the EU summit now find themselves isolated, with the rest of the EU having zero incentive to help the City of London and its key financial district that comprises such a large portion of Britain’s economy. At least for now the British people agree with their prime minister, 62-19, according to the last poll I saw.

On Monday, Cameron defended his use of the British veto as being in the “national interest,” but the strain in his coalition is such that his deputy, Nick Clegg, refused to sit alongside him in the House of Commons; Clegg claiming the veto was bad for British business even as Cameron’s fellow Tory MPs applauded the prime minister’s “bulldog spirit.”

Or as opposition leader David Miliband put it, “This is the first veto in history not to stop something. The (EU’s) plans are going right ahead,” adding that it was “a very dangerous moment” for Britain with far-reaching consequences.

“Fifty-six years ago Anthony Eden walked away from the founding of the European Union and we paid the price for 20 years. This has been an Anthony Eden moment for David Cameron.

“If you look back to what the Prime Minister was warning of just two months ago – namely the danger of a caucus of 17 countries bossing the rest of the European Union – he has engineered a situation where it is 26 countries together and Britain on its own without a say for the first time since we joined the European Union.” [London Times]

Then again, just how united will the 26 be?
IMF Managing Director Christine Lagarde, given all the above, rightly concluded :

“It’s not a crisis that will be resolved by one group of countries taking action. It’s going to be hopefully resolved by all countries, all regions, all categories of countries actually taking action.”

If the issues are not dealt with decisively, the global economy could confront the same threats that pushed the world into the Great Depression of the 1930s.
“(The) risk is that of retraction, rising protectionism, isolation. This is exactly what happened in the Thirties and what followed was not something that we all are looking forward to.”

“It’s a question of actually facing the issues, not being in denial, accepting the truth, accepting the reality, then dealing with it.”

It doesn’t help the euro region is unraveling to the extent the Northern nations are abandoning the periphery, or as PIMCO’s head of European portfolio management Andrew Balls told the Wall Street Journal, “We are seeing this deglobalization, a ‘de-Euroization,’ of the euro zone. Investors are going back to their own markets. They may still hold bonds, but they won’t have them spread across the euro zone as they had before.”

Not good for the likes of Italy, and increasing the chances for a deep recession.

And now you have situations such as France and Britain squaring off. Both French Prime Minister Francois Fillon and the French central bank chief broke protocol in saying the ratings agencies should target Britain’s triple-A credit rating before they do France’s.

Christian Noyer, governor of the Banque de France, said that he did not regard the threat of a downgrade on Paris “as justified, based on economic fundamentals,” adding, “Or if it is, they should start by downgrading the UK, which has a bigger deficit, as much debt, more inflation, weaker growth and where bank lending is collapsing.”

Prime Minister Fillon, on a visit to Brazil, said: “Our British friends have a higher deficit and more debt, and I would say that the ratings agencies have not yet noted that.”

This as France’s own AAA is under imminent threat of being knocked down a peg.

At first, David Cameron’s office in London said nothing, but then Deputy Prime Minister Clegg told Fillon to “calm the rhetoric” on the UK economy, and that remarks from members of the French government “were simply unacceptable.”

Of course this stems from Prime Minister Cameron’s veto of the EU-wide compact involving all 27 Euro states. At least Britain was then given an out of sorts and invited to participate in negotiations on governing the regions’ national economies.

Going back to the Dec. 8-9 summit and Cameron’s intransigence, an official described the scene to Reuters:

“(Cameron) was effectively asking for a softening of regulation on Britain’s financial sector at a time when many voters and politicians believe banks are largely to blame for the crisis Europe is suffering and want tighter regulation on the sector.”

It was as if the French had been waiting for this for years, never believing Britain belonged in the European Union in the first place. The official said, “The French were using all this as a really perfect alibi to get rid of the British. Sarkozy used the proposals of the British to justify an intergovernmental treaty,” with Cameron playing right into Sarkozy’s hands.

In just 10-20 minutes, even Britain’s allies in the EU agreed that Britain didn’t deserve an opt out or exceptional treatment for their financial services and it didn’t fly at all. The non-eurozone member states decided they wanted to be in and left Cameron completely isolated.
Various opinion…on all topics.


Editorial / Washington Post

“Two years ago, on Dec. 14, 2009, Greek Prime Minister George Papandreou pledged that his debt-ridden country would ‘address and resolve, once and for all, deep-rooted problems that are holding the nation back.’ As if to mark the anniversary, the International Monetary Fund brought out a report this week, whose main conclusion is that Greece is not only not reforming fast enough but ‘falling behind across a range of policies.’

“Instead of shrinking, the Greek budget deficit is growing. And instead of growing next year, as the IMF once predicted, the Greek economy will contract again. In short, while Europe’s leaders turn their attention to ratification of a long-term plan for fiscal discipline across the 17 nations that use the euro, they still don’t have a solution for the situation that plunged the continent into crisis in the first place – and could yet trigger a meltdown.”
So what’s the problem in Greece? Revenue collection, i.e., further tax evasion.

Martin Feldstein / Wall Street Journal

“The recent eurozone summit was a double failure. It failed to achieve the increased European political integration that was the primary goal of German Chancellor Angela Merkel and the other European political leaders. And it failed to improve the outlook for eurozone sovereign bonds because those politicians continued to insist that only a fiscal union and political integration could limit the interest rates on sovereign debt….

“Yet Britain’s unwillingness to modify the existing treaty without additional safeguards for the British economy means that the new rules would apply only to the 17 eurozone countries and others that wish to join them, but that they don’t constitute an official EU treaty and therefore cannot be enforced by the commission and other EU institutions.

“So there really is no enforcement mechanism for the new budget rules, even if all of the eurozone governments agree to sign a new accord.”

Robert Samuelson / Washington Post

“By now, it’s obvious that adopting the euro was a colossal blunder. It may rank as Europe’s worst policy mistake since World War II. The virtues of the common currency – it reduced transaction costs and the uncertainty of fluctuating exchange rates among national monies – were temporary. Its vices seem permanent or, at least, semi-permanent: the mounting economic costs of saving the euro; the growing nationalism from arguing over who’s to blame.
“Do not expect some magical ‘solution.’ Europe has entered an economic and political purgatory from which there is no early escape. On paper, the crisis countries (so far: Greece, Portugal, Ireland, Italy and Spain) might benefit from abandoning the euro and resurrecting national currencies. They could then devalue these currencies, spurring exports and tourism. But in practice, this choice is dangerous and maybe impossible.

“Any hint that a country might dump the euro would trigger runs on banks, as depositors would seek to withdraw their euros. Banks would collapse. Deprived of buyers for their debt, countries would default. This would impose further losses on banks inside and outside the defaulting country. Without viable bans, borrowers would be starved for credit. There would be capital controls restricting the shift of funds abroad. If one country (say, Greece) left the euro, it might precipitate runs and capital flights elsewhere. Writing in the Financial Times, Citigroup chief economist Willem Buiter sketched this grim outlook:
“ ‘Disorderly sovereign defaults and eurozone exits…would drag down not just the European banking system but also the North Atlantic financial system…The resulting financial crisis would trigger a global depression that would last for years, with GDP likely falling by more than 10% and unemployment in the West reaching 20% or more. Emerging markets would be dragged down too.’”

Wolfgang Munchau / Financial Times

“To solve the crisis, the eurozone requires, in the long run, a fiscal union with a prospect of a eurozone bond and, in the short run, unlimited sovereign bond market support by the European Central Bank. What we now have is no treaty change, no eurozone bond and no increase either in the rescue fund or in ECB support.”

Of course what’s so stupid about this whole freakin’ mess that threatens to take the entire world down is all Europe had to do was stick to the ceilings they adopted with the Maastricht Treaty 20 years ago when the euro was created, starting with limiting deficits to 3% of GDP.
Anatole Kaletsky / London Times
“And the winner was – David Cameron. With European markets collapsing after last Friday’s ‘historic’ summit meeting, with France about to lose its credit rating and with the German parliament seething at Angela Merkel’s failure to deliver on her promise of automatic sanctions for breaches of the budgetary ceilings, it looks like the new eurozone treaty may not even be written, much less signed or ratified. Far from isolating or weakening Britain’s position, the Prime Minister has protected the fundamental EU treaties from ridicule and disrepute.

“As details of the Franco-German ‘fiscal compact’ emerged over the weekend, it became clear that this ‘comprehensive’ and ‘final’ response to the eurozone crisis was no more comprehensive or final than all the previous failed summit deals. The only truly firm decision taken last week was to hold another meeting in three months’ time. At that point, all the impossibly contentious issues dividing France and Germany would somehow be miraculously resolved. Until then, eurozone citizens and global investors will be right to remain skeptical. The reasons for skepticism can be grouped under three headings: finance, politics and economics.

“Starting with finance, the summit deal completely failed to satisfy the two conditions necessary to restore confidence among the creditors to eurozone governments and depositors in the Greek, Italian and Spanish banks. First, the eurozone must be converted into a genuine fiscal union. Second, the European Central Bank needs to provide potentially unlimited financing to the weaker euro governments to bridge the gap between the political timetable for creating a fiscal union, which will take several years, and a market timetable that is measured in weeks or months. The summit deal failed utterly on both these counts….

“To make matters worse, the process of fiscal union has not been backed as expected by the ECB. Far from increasing support for Greece, Italy and others, the ECB reduced its purchases of their bonds to just 635 million euro last week (from as much as 20 billion previously). Instead of offering Italy and Spain bridging loans, the ECB produced a bizarre plan to lend money covertly through a cockeyed scheme that in another context might be described as money laundering.

“The ECB announced last week that it will offer all banks in the eurozone loans for three years in unlimited amounts, at an interest rate of just 1%. The banks will then be able to use this money to buy bonds issued by their own governments, in most cases yielding 6% or more, thus picking up five percentage points of profit by hoovering up whatever debts their governments might choose to issue in the months ahead….

“If the Greek or Italian governments default on their debts the Greek and Italian banks will go spectacularly bust – but these banks will go bust anyway if their governments ever default. Thus all the incentives for bank managements are to go for broke, risking their entire capital in the government debt markets and making maximum use of the new ECB credit lines.”

Insane. And I couldn’t agree more with this conclusion from The Economist regarding the summit.

“Although the compact was greeted as the acme of European solidarity, it is more likely to provoke strife. The summit poured cold water on the idea of Eurobonds, in which all members would share some or all of the troubled economies’ burden of debt. Instead the adjustment is being imposed almost entirely on deficit countries, guaranteeing that it will be long and painful. If in the coming years elected governments that impose austerity stir up civil unrest, outside enforcers in the EU will before long become a target for popular rage.”