piigsty

According to BBC News and the UK Guardian, it appears German Chancellor Angela Merkel is still keen on supporting the UK Government’s long held desire to remain in the European Union but not by dispensing with the founding principles of the entire project. Looks like British PM Cameron’s tight rope walk with UKIP + eurosceptic backbenchers on one side and those pesky but somewhat more vital EU allies on the other, is starting to enter some strong headwinds.

Part 3 of the PIIGSty analysis based on Matthew Feeney’s article of Reason.com continues with an insight into the European Central Bank (ECB) President, Mario Draghi.

3. Mario Draghi ECB President 

Draghi is a relatively fresh addition to the European saga. The colourful choice of former Bank of Italy ( Italian central bank) governor to succeed the shrewd Frenchman Jean-Claude Trichet has managed to stir things up, not least considering the ECB – a bank built on the inflation averse German bundesbank model – is now led by an Italian. Considering the current crisis in Italy with Mr. Monti’s technocratic government desperately trying to piece the country back together after decades of political instability, corruption and fiscal irresponsibility, Draghi is unfairly battling prejudice from day 1. After his recent London pledge in late July to do ‘whatever it takes’ to protect the euro, Draghi has since failed to accurately outline what ‘whatever it takes’ means (because this means very different things to each key player).

In early August, with Draghi alluding to expanding the scale of bond buying using undeniably direct language, the ECB appears set for a showdown with reluctant member states (and a good thing too!) There are signs that the cold German approach is facing a thaw and warming to the idea of the ECB strengthening its bond buying effort to cover the big 2 – Italy and Spain but this isn’t without its domestic detractors. To placate these, government rebels have demanded ECB operating procedures be changed to provide for a German veto (effectively neutering Draghi by politicising the independence of the ECB – so very unlikely to happen). In the meantime, accusations of ECB “mutating into a state financier and a ‘bad bank’” are being thrown about.”

While most of the this is typical political chest pounding without substance or particular importance, the reality is that an ECB which unilaterally chooses to dish out bail-outs using mostly German funds could be (pretty fairly) accused of doing this at the expense of Germany’s own best interests. Hence, questions arise as to why Germans would pay in the first place. ECB ‘independence’ remains factually correct as far as any offspring is ‘independent’ of its watchful parent.

A fuzzy ECB is no help when signs of EU solidarity aren’t too convincing. PIIGSty has long said that a collective comprehensive plan to ‘save the eurozone’ is the real Holy Grail eluding European leaders. While Draghi and others continue to drag their feet while promising the sun, moon and stars (yet not a single cent), his words inevitably just adds to uncertainty and inertia as member states publicly argue and the markets bounce around unconvinced. Plans such as ‘fiscal’ or ‘banking’ union – despite German support  – remain completely undefined as the powers that be pray for growth. Without a plan, investors become convinced that messy defaults are just around the corner. Would you invest your savings in Italy or Spanish debt right now?

The Euro-jitters continue…

It hasn’t helped matters that the Finnish Foreign Minister has been speaking frankly to the British Daily Telegraph about the oncoming currency crisis and the necessity to prepare for just the possibility of a break-up. Mr. Tuomioja spoke awkwardly frankly against the changing of current bailout (ESM) rules and the writing of blank cheques for further bailouts and (damningly) voiced a  personal distrust for Mr. Draghi (among others). Although rebuffed later by other Finnish ministers, the consequences of prolonged inaction in Europe are becoming graver as whispers of a managed mechanism for ejecting weak links from the euro resonates across the EU-27.

The inscrutable Angela Merkel is the one certainly on which the European project precariously sits and, as a result, is feeling heat and wrath in equal measure. With her own Bundesbank sounding the alarm over Draghi’s new August announcement of a Italian-Spanish bond buying campaign, her task to thread a very delicate needle at home and abroad is a near impossible one. Eventually though, sanity must prevail and difficult decisions made regardless of the political cost which PIIGSty believes will be forthcoming from her government, when the dust truly settles – possibly this Autumn.

EU Debt Seniority

In the meantime, until a comprehensive plan is published, issues like the seniority of EU bailout debts remain contentious. Under current ESM (European Stability Mechanism – the main bailout fund) rules, seniority means the order of repayment of debt by borrowers in the case of default.  When you throw into the mix a Spanish bank (not sovereign/country) bailout of over €100bn, then the waters become murky.

Ultimately (which will surprise no one) it will take a greater crisis to really give Draghi sufficient cover to deliver a politically acceptable plan – something he has made clear himself. A more interventionist ECB is the last thing Germany will accept and so member states must request a bailout (of whatever form). Small wonder investors are cashing in their Italian and Spanish bonds and preparing for the worst. Draghi must remember – actions do speak louder than words, not least to the markets he needs to tame or a least calm. Like the EU politicians, Draghi should stop waffling about wanting to ‘save the euro’ and actually do it.

Jeff Cox (CNBC) opines that the European debt crisis is likely to last a further 2 to 5 years as the dual effort to achieve both..

1. Austerity in public spending
   
2. A workable long term debt repayment (or forgiveness) plan for European sovereign debt

Both of these long term goals will inevitably require an adjustment phase. Italy, with its bond yield straddling 6-7% and its €1.9tn debt is a problem that won’t go away so long as the markets believe an Italian default is, at least, plausible. Sure, the disposal of Silvio “Bunga Bunga” Berlusconi as Italian PM and his replacement with the decisively less colourful, technocratic (and market friendly) two time European Commissioner Mario Monti, is certainly a stabilising factor (as Italy needs to pass a big reform package to reestablish credibility and lower its bond yield/financing costs to sustainable levels…around <5% from 6-7% currently).

However the problem is not financing, its solvency. The national debt of Italy might simply be a bridge too far to saddle on the average Italian citizen (as the Greek situation has shown). Volatility is caused by the uncertainty over the imponderables – those technical points that are being kicked down the road so as not to alarm the markets. Regardless, according to Cox, the ‘European Dilemma’ is being seen (perhaps simplistically) as a direct extension of the US financial crisis which begin in earnest with the collapse of Lehman Brothers in late 2008. The volatility we are seeing is because short term investors (traders) are very responsive to perceived changes in risk (and everyone seems to be dealing in the ‘short term’ at the minute). Right now, with the prospect Central Bankers intervening in markets (as the ECB does, buying Italian bonds) , a feared sovereign debt downgrade in France (and a Presidential election in April/May 2012) , a politically charged atmosphere in Washington DC (Presidential election in November 2012) coupled with the continuing austerity plans restricting growth, Europe will likely endure another “mild” recession in 2012.

According to an editorial in the Wall Street Journal (WSJ), the source of the European debt crisis lies in the failure of the European welfare state. With the PIIGS debt piles clearly undermining the sovereignty of each nation rather than bolstering it, European states have failed to grow fast enough to pay for their massive entitlement programs (and most decided to tax the hell out of its citizens for the privilege).

For Italy, with aging populations (20% of Italians or 12m people are 65+ ) and low birth rates (Italy ranks 207^th of 221 territories/countries), pensions today cannot be fully funded by worker contributions at the entry level. The maths don’t work.

Italys failure was a political failure to tackle the low tax/high spend economy and the protected power of various trade ‘guilds.’ This was not helped by the ‘concertazione’ (concert) of Italian coalition politics which makes for unwieldly and shifting poliitcal blocs, making a cohesive and stable federal government next to impossible (hence the endorsement of ‘strong’ leaders instead such as that of Silvio Berlusconi (PM 1994-1995, 2001-2006, 2008-2011) with at least the appearance of control.

It boils down to this. The hard remedy to Europes problems lies in the reform or complete destruction of the European welfare state. But tough reforms requires strong leadership. The lesson? “Never to become a high-tax, slow growth entitlement state, because the inevitable reckoning is nasty, brutish and not short.”

PIIGSty prides itself on not rehashing the breaking news of the day, each and every day (and we know the European mess is a tad depressing, especially if you’re Irish, Italian, Greek or Portuguese)

Credit where credit is due, the Guardian’s (UK) Tom Meltzer has sought to address that burning capability question hanging over the head of New Italian PM Designate Mario Monti. Will Mario Monti really become a European ‘Super Mario’? His comparative analysis provides all the necessary relevant facts.

(Our favourite line: Mario Monti’s Antagonist: Silvio Berlusconi. Not a turtle)

BBC News has a really handy interactive graphic on the eurozone debt crisis. It has 4 sets of data based on Eurostat figures – Debt:GDP ratios, Budget Deficit, Economic Growth and Unemployment – from 1999 to Q1 2010 (not bang up to date but still useful to compare the PIIGS and others over the past 11 years). Use the indicators to compare all 17 eurozone countries (and the UK, as a bonus…)

PIIGSty has put together 3 useful images comparing each of the PIIGS to each other on the ‘big 3’ issues: Debt, Deficits and Growth (click on each category to see the Eurostat Excel tables)

Debt (GDP:Debt Ratio)

Budget Deficit

Growth