The Economist on the European Crises (10-17 September)

Over the past week, there have been a few really valuable insights from the Economist on the euro crisis and the European debt crisis. Of course, we at PIIGSty are very proud of our summaries so, with you in mind, we’re giving you a run down of our favourite three articles. Heres a PIIGSty pictoral summary of all 3.

Full summaries of the articles are below…

Article 1: Fudge, the Final Frontier (10 Sep)

Main focus here is on the debt crisis in the eurozone (EZ).

This article contains a great deal of useful statistics but for those not aiming for a Nobel prize, heres a summary of the main points

  • Early August, the ECB began buying Italian/Spanish bonds (government debt) to drive up demand and provide cheaper financing for those governments than the market would otherwise have provided. This stabilised the situation but as September has progressed, the uncertainty demons are back . The ECB isn’t happy buying bonds and neither is Germany as expressed by Jens Weidmann the President of the German Bundesbank (Central Bank). The ECB is realistically only quasi-independent as it needs German financial support at a time when German support in any political/economic institution is dwindling.
  • European bank shares (European banks, notably Northern European banks hold huge tranches of PIG debt) have taken a battering. Since July, German banks ↓36%, French ↓43%, Italian ↓38%. Banks are in some respects on shakier ground than in the immediate post-Lehman phase of the crisis in Late 2008 (credit default swaps at a high)
  • The Swiss Frank has binded itself to the euro – heralded by Euro leaders as a real indictor of strength

Uncertainty in 3 areas

  1. European governments are weakening making it uncertain if they can ignore their electorates, pass austerity plans or pass the EFSF reforms agreed on July 21.
  2. Debt/deficit controls jeopardise Europes ability to grow out of this crisis (which make Baldwin’s ‘recession cycle’  likely to repeat 
  3. The size of the €440bn EFSF is too small to help in a worst case scenario Spanish debt, for example, is €1.9 trillion making it TBTR (too big to rescue)

And, of course, Eurobonds

  • Big leap to fiscal union which would, as the Germans content, require changes to existing EU treaties or a new treaty (something which Commission President Barosso disagrees with 
  • German borrowing costs would rise sharply, weaker countries might be convinced to stay in a currency they should never have been in (i.e. you guessed it, Greece).
  • Germany has a policy choice (1) the European Option – Save the euro by sacrificing growth and GDP to prop up the PIIGS (2) the German Option – adhere to traditional economic/monetary stability and aim for a smaller more consolidated fiscal union with a smaller membership

Is disintegration of the EZ likely? Most, such as euro historian David Marsh and monetary historian Barry Eichengreen say no (as does in our publication). It would be catastrophic and hugely damaging to Germany causing a depression, bank runs and defaults on the periphery of Europe.

The article ends with some proposals for the EFSF (Since beefing it up more is a non-starter)

  • Turn it into a bank, meaning it can borrowing more from the ECB
  • Use the current design and allow the ECB to issue guarantees to sovereign bondholders
  • Allow EFSF to offer investor protection with the ECB helping out with cheap loans

Article 2: Charlemagne’s Notebook – The Euro Crisis ‘Time is Running out.’  (12 Sep)

Main focus here n the heralded opinion section provides a number of bite-sized food for thought on the euro crisis…

  • The EFSF reforms from July can’t protect Italy or Spain from default
  • ECB bond buying programme received a stunning rebuke via the resignation of German chief economist Jurgen Stark
  • Germany becoming more comfortable (and saying the markets are too) with jettisoning Greece altogether – they’re not evening following the EU-IMF reforms as indicated in their poor performance in quarterly reviews
  • Greece leaves the euro – so what? Who knows. They might get the next tranche of bailout funding (barely). If they leave or are forced out (which isnt possible in the treaties) some suggest this could lead to the mother of all crises, a Lehman 2.0 or Lehman on steroids.
  • Will more countries, like Finland, demand collateral for their portion of the bailout funds to Greece?

So many branches to the crisis and yet no one is addressing the root problem. Conclusion: The problem is now, not tomorrow.

Article 3: How to Save the euro  (17 Sep)

The Economist proposes a rescue plan for the euro should be as follows:

(1) Admit which countries are in the worst shape and help them restructure their debt while protecting those that are currently in good shape

  • There is a difference between solvency and liquidity. Greece is likely insolvent (i.e. literally can’t pay its debt with the current size of its economy). Italy/Spain are solvent but illiquid (they can pay their debts based on their economy but cant access the funding to do that)
  • By not explaining and acting, the line is blurred and the crisis spreads as investors equate the two are equals rather than apples and oranges.
  • Scrap the July 21 Greek 2nd bailout plan and start again – with an orderly write down

(2) Shore up European banks to withstand nations defaulting

  • Provide some breathing space so solvent nations can pass reforms and remove themselves from the domino line up

(3) Shift EZ policy from austerity to growth plans

  • As Baldwin suggests (<link>), the continous recessionary cycle is self defeating
  • More austerity contracts the economy rather than grows it and the disease spreads from government coffers into the banks and sovereign sustainability
  • Structural reform and liberalisation is a better option – free up the private sector and reduce the size of the public sector

(4) Design a proper system so this can never happen again

  • Short term solutions should be ALL we’re talking about because we only have short time.
  • One option – ECB to stand behind all solvent countries sovereign debts – but even a small scale bond buying scheme has seen German economist Stark resign due to perception of politically tinkering around rather than rigorously adhering to a monetary policy
  • Whats the point in doing this if Italy defaults and global depression occurs? Perspective here and a sense of urgency is vital.

The Economists view is that we need to stop being theorists and bemoaning the tangential route the euro has taken away from its preordained path at its creation. Who cares about that now?

Germany leaving the euro and setting up a DM 2.0 would see its exports priced out and slam the breaks on German growth (which powers the EU). If the others broke away, those peripheral PIIGS would devalue sharply exploding a competitiveness gap between North and South. Europes single market would come under huge pressure amid acrimony and no doubt a return to protectionism. The damage and costs of a EZ breakup are massive

Ironically, bold action by the ECB and others may make the costs significantly less in the long run because the perception of action and collective economic governance will reduce bond prices and ultimately allow the PIGs to return to the bond markets far earlier (as well as reducing bond prices for all others).  The biggest worry is that any action would let the PIIGS off the hook from making painful reforms via their austerity plans. But allowing a big fish to implode such as Italy and Spain just to teach the minnow Greece a lesson seems a bit ridiculous.

Whatever about the future of a ‘fiscal union’ compromising an increasingly fiscally integrated core and what effect this might have on the surrounding EU but non-EZ members in unknown. This is a nervous time. Making big decisions always makes people nervous. But in the end, as the Economist states ‘the euro has reached the point where nobody is going to get what they want – something that needs to be spelled out to the Germans more than anybody.”


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