By Mike Whitney
“In every crisis there’s a point of no return….I’m increasingly convinced we’ve already passed that point of no return in Europe. The banks won’t lend to each other, the Germans won’t do Eurobonds, and the ECB won’t act as a lender of last resort. The confidence fairy has left the continent, and she isn’t about to return. Which means, as we used to say in 2008, that things are going to get worse before they get worse.” –Felix Salmon, Reuters
Stocks rose sharply on Monday on news that France and Germany are close to a breakthrough agreement that will resolve the deepening debt crisis. While the details remain sketchy, the grand bargain appears to involve some pooling of debt (eurobonds?), a bigger role for the European Central Bank (ECB), and an intrusive EU oversight panel with veto-power over state budgets. There are also conflicting reports about a $600 billion IMF bailout for Italy, and a fast-track launching of the European Financial Stability Fund (EFSF), the emergency facility that was expected to end the crisis but has faltered through lack of funding.
While the rumours of progress continue to fly, EU leaders are still light-years from any real solution. Meanwhile, conditions in the credit markets continue to deteriorate while interbank lending languishes in a deep-freeze. Overnight deposits at the ECB have skyrocketed to around 250 billion euros while EU banks have become increasingly reliant on the ECB for funding. It’s all bad. The turmoil in the credit markets is leading to another recession or worse.
The eurozone is now in an irreversible slide that will end in the dissolution of the 17-member monetary union. The frantic efforts of German and French leaders to create a makeshift fiscal union on-the-fly is just “too little, too late”. There’s neither the popular base of support nor the political will for a United States of Europe. And that’s not what German Chancellor Angela Merkel or French PM Nicholas Sarkozy want anyway. What they want is a swift end to the crisis that’s now reached the epicenter of the Europe and is pushing yields on German bonds higher.
The significance of last Thursday’s “failed” bund auction has not been lost on Merkel, who was deeply shaken by the results. If the bond vigilantes can make short-shrift of German bund, then no one is safe. And no one is safe. Yields are rising across the board, even in surplus countries like Netherlands and Finland. That means the focus has shifted from deficits to something even more basic, like survival. Investors are now pricing in the possibility a collapse of the eurozone.
On Friday, yields on the 10-year German Bund rose above those of equivalent UK gilt, which means that it will cost more for Europe’s industrial powerhouse to borrow in the capital markets than it will for debt-stricken England. Does that make any sense? Only if one assumes that investors think that it’s too risky to be in euros at all. Then it makes perfect sense. After all, the strength and size of one’s economy does not necessarily make their bonds more attractive, especially if there’s there’s significant credit risk due to the ECB’s refusal to underwrite the debt. Absent an ECB guarantee, investors will continue to flee eurozone bonds. And, why not? After all, investors expect “risk free” assets to be risk free.
Since, last week’s Bund bloodbath, the German position on many of the key issues has softened. Here’s the story from Die Welt:
“The Bundesbank no longer rules out emission of common European bonds – so-called Eurobonds. Prerequisite, however, is closer financial integration for the euro countries. “This means joint control over the budgets of the member countries, including intervention rights if individual countries should violate the agreed rules,” said Bundesbank President Jens Weidmann to the “Berliner Zeitung”….
By the next European Council meeting, the Summit of Heads of State and Government at the end of the first week of December, the Chancellor could have negotiated a deal. Whereby their agreement could involve Eurobonds or a stronger commitment from the ECB in exchange for a promise from everyone in Europe to put their economies on a more sustainable path.” (“Officially Eurobonds are taboo but behind the scenes nothing has been ruled out”, Credit Writedowns)
If the Bundesbank supports eurobonds, then Merkel can be expected to fall in line, too. As for the “joint control over the budgets of the member countries, including intervention rights if individual countries should violate the agreed rules”; it’s a complete red herring. In fact, these sovereignty-eviscerating oversight panels are already in place in Italy, Greece, and Portugal, so what’s the point of acting like its something new? Merkel and Weidmann are just invoking “budget discipline” as a public relations smokescreen for greater debt pooling which is ferociously opposed by most Germans.
There’s also talk of a new “Stability Pact” which would circumvent existing treaties and skip the democratic process altogether. (The politicians want to avoid a public vote at all cost.) Here’s the scoop from Reuters:
“German Chancellor Angela Merkel and French President Nicolas Sarkozy are planning more drastic means – including a quick new Stability Pact – to fight the euro zone sovereign debt crisis, Welt am Sonntag reported on Sunday….
The report, which echoed a Reuters report on Friday from Brussels, quoted German government sources as saying that the crisis fighting plan could possibly be announced by Merkel and Sarkozy in the coming week.
The report said that because it would take too long to change existing European Union treaties, euro zone countries should avoid such delays be agreeing to a new Stability Pact among themselves – possibly implemented at the start of 2012….
The European Central Bank should also emerge more as a crisis fighter in the euro zone. …”Based upon these measures, there should be a majority within the ECB for a stronger intervention in capital markets,” Welt am Sonntag said. It quotes a central banker as saying: “If the politicians can agree to a comprehensive step, the ECB will jump in and help.”…
In Brussels on Friday, euro zone officials said a push by euro zone countries towards very close fiscal integration could give the ECB the necessary room for manoeuvre to scale up euro zone bond purchases and stabilise markets.” (“Germany, France plan quick new Stability Pact”, Reuters)
If the report is true, then Merkel has done a complete 180 from her original position. Up to now, she has consistently opposed allowing the ECB to act as lender of last resort. Here’s more from Reuters:
“The European Commission, the EU executive arm, put forward proposals on Wednesday to grant it intrusive powers of approval of euro zone budgets before they are submitted to national parliaments, which, if approved, would effectively mean ceding some national sovereignty over budgets.
This could lead to joint debt issuance for the euro zone, where countries would be liable for each others’ debts.” (Reuters)
How do you get from “intrusive powers” and “ceding national sovereignty” to “joint debt issuance for the euro zone”? That’s a bit of a stretch, don’t you think? What the authors appear to be saying is that once nations abandon democracy altogether, then the Brussels-Berlin Axis will issue eurobonds to rebalance the system so that Soviet Europe works in a way that maximizes profits for the banksters. Is that what this is all about?
Sure it is. And if you had any doubts, then get a load of this in Yahoo Finance:
“Euro zone states may ditch plans to impose losses on private bondholders should countries need to restructure their debt under a new bailout fund due to launch in mid-2013, four EU officials told Reuters on Friday.
Commercial banks and insurance companies are still expected to take a hit on their holdings of Greek sovereign bonds as part of the second bailout package being finalized for Athens.
But clauses relating to PSI in the statutes of the European Stability Mechanism (ESM) – the permanent facility scheduled to start operating from July 2013 – could be withdrawn, with the majority of euro zone states now opposed to them.
The concern is that forcing the private sector bondholders to take losses if a country restructures its debt is undermining confidence in euro zone sovereign bonds. If those stipulations are removed, most countries in the euro zone argue, market sentiment might improve.” (“Eurozone may drop bondholder losses from ESM bailout”, Yahoo Finance)
So the investors who bought bonds from countries that have been downgraded, will not lose money on their crappy investments. Instead, eurozone taxpayers will stump up the money so it doesn’t “undermine confidence”. Sound familiar?
So, what’s the endgame here? What needs to happen to save the eurozone from disintegration?
First, the ECB must be given a green light to provide a blanket backstop for sovereign bonds to keep rates down. Second, there must be some form of instrument (eurobonds) to collectivize debt in order to counterbalance capital flows from the surplus countries to the perimeter. Third, there must be greater fiscal AND political integration to establish the type of institutions that transform the 17-member confederation into a real country.
Does any of this sound even remotely possible in the next couple weeks?
No, it doesn’t. Which is why we can expect an economic catastrophe of historic proportions.