19.10.2011
Big bazooka or water pistol?
As the European leaders gather in Brussels on October 23, it could be last chance saloon for the euro zone, writes Eddie Ford
At the G20 meeting of finance ministers and central bank governors in Paris on October 15, Tim Geithner, the United States treasury secretary, apparently said there were “six days to save the world” - the asteroid is approaching. So by the time you read this article you should know whether or not his prediction has come true. Unless, of course, you were too late …
What Geithner really meant was that the entire euro zone project was in very real danger of imminent collapse unless European leaders came up soon with the “bold” and “decisive” action they have been promising for weeks now. Failure to do so, obviously, would have catastrophic consequences for the world economy, heralding a new depression. Then it would just be a question of exactly how many banks and financial institutions collapse, and in turn how many new ‘failed states’ were created in the process. One thing that is absolutely guaranteed is that under such calamitous conditions it would be the working class which gets hammered into the ground by a despairing bourgeoisie out to save its own skin - either that or the mutual ruination of all classes, as Karl Marx warned in the Communist manifesto.
More specifically, Geithner believes - not without reason - that only the construction of a massive financial ‘firewall’ can protect the euro zone against contagion from a Greek default, a prospect that draws closer with every day that passes. In the view of the US administration, for far too long the French and German governments, the ‘powerhouses’ behind the euro zone - or at least that is how it seemed up to now - have dithered and dallied over the Greek question, almost treating it as a little bit of local difficulty rather than a crisis with potentially deadly global consequences. One way or another, vast amounts of money need to be pumped into the chronically ill euro zone economy, so as to ‘neutralise’ the Greek problem and prevent Italy, Spain, Portugal and Ireland spiralling downwards into greater debt and possible default. Not to mention the small matter of buffering up German and French banks, especially the latter, which, of course, have lent billions of euros to Greece, Ireland, Portugal, etc - the sick men of Europe - and hence are extremely vulnerable to a further outbreak of contagion.
Make or break
In other words, make or break time for the European Union’s banking/financial system - and maybe for any prospects of a recovery in the US, which is sliding into recession or even worse. Call it “shock and awe” or a “big bazooka” - even going “nuclear”, as advised on August 8 by Stephen King, HSBC’s chief economist[1]- but the big guns need to be brought out, not a water pistol. Yet are there any signs of this actually happening?
Not so far. Even though there are only six days left to save the world, which you would imagine might impart a certain degree of urgency to proceedings, the Paris conference contented itself with issuing a standard ‘Don’t panic’ communiqué calling for “further work to maximise the impact of the European Financial Stability Facility in order to avoid contagion”. That is, boost the EFSF mechanism’s bailout fund to at least €2 trillion, rather than the measly €440 billion currently available - that barely buys you a sticking plaster these days - and recapitalise the banks, probably through some system of state-backed guarantees.
The communiqué went on to commit the G20 nations, in theory anyway, to ensuring that the International Monetary Fund has “adequate resources” to deal with the problems confronting Europe - meaning that the IMF, in the words of its managing director, Christine Lagarde, has been asked to devise “instruments that are more flexible” and “more short-term”, thus allowing countries that are in “good economic health, but in difficulty” the chance to “resist” contagion. Officials also told Bloomberg that they are considering naming up to 50 banks deemed “systemically important” to the world economy and therefore more deserving of extra capital. Finally, the Paris communiqué said that the upcoming (and delayed) emergency EU meeting on October 23 at Brussels must “decisively address the current challenges through a comprehensive plan” - which, it seems, will be presented with much fanfare and the loud popping of finest French champagne to the G20 summit meeting at Cannes on November 3-4 hosted by Nicholas Sarkozy. Well beyond six days by anybody’s calculation.
However, Wolfgang Schauble, Germany’s finance minister, immediately poured cold water over the idea that the Brussels meeting would produce a “miracle cure”, saying that a “final package” would not be in place until the Cannes summit. Keep moving the deadlines forward for one more drink at the last chance saloon. Unsurprisingly, Schauble’s comments dismayed the markets, with the result that on October 18 the Dow Jones industrial average plummeted 247 points by the close of trading, oil prices dropped downwards again (after a temporary stabilisation) and the euro fell for a second day against the dollar. This flight of cash from risky-looking European banks has been an accelerating trend over the past two months, as investors seek more traditional safe havens - ie, funnelling their money into US treasuries, notes and short-dated paper alike.
There is a certain irony, of course, to this recent flow of cash to US government bonds, as the unfolding economic crisis has in part being driven by a fear about the quality of these very same assets - especially after Standard & Poor’s August downgraded the US government’s credit rating by one notch. With impeccable logic though, most investors reason that, as the US is the world’s only superpower - forget China and nonsense like that - then, for all its current deep economic difficulties, there is next to no chance of it suddenly going down the tube. Unlike the euro zone. The mighty dollar, backed up by the even mightier US military, is still your best bet.
Schauble had even more bad news for the finance houses. He bluntly stated that German and French banks must accept at least a 50% ‘haircut’ (write-down) on Greek debt. Such a message is a direct rebuttal to the intense lobbying by Deutsche Bank for only a limited write-down on loans to Athens - something around the original 21%, as agreed in July by EU leaders, when they approved the second bailout deal for the country. Furthermore, as alluded to at the Paris meeting, Schauble insisted that the banks needed to be “better capitalised” and “better regulated”. That is the “best way to ensure that we don’t have an escalation in the crisis due to a collapse in the banking system” - an apocalyptic scenario. Therefore, Schauble argued, the euro zone needs a “bomb-proof” firewall to protect the vulnerable countries; not easy, as he readily admitted, when banks had lost trust in each other and were refusing to conduct ‘normal’ lending.
Quite plausibly, the demand for further write-downs could force several governments, including Angela Merkel’s administration, to nationalise or part-nationalise various financial institutions. Doubtlessly some comrades will hail this as a ‘socialist’ advance. Belgium, for one, has come under particular pressure in recent weeks following concerns that it will need to spend billions of euros rescuing its banks despite already pumping €5 billion into Dexia bank to prevent its total collapse. According to rough, back-of-the-envelope calculations, up to 30 banks in the euro zone may need an extra injection of capital after the writing-off of Greek debt. The US investment firm, BlackRock, concluded after an investigation into the Greek banking system - or what passes for it - that some of the country’s major financial institutions will need to be “temporarily” nationalised when and if an ‘orderly’ default is finally agreed upon.
Revealing the tensions within the German government, Merkel told senior members of her own Christian Democratic Union that the Brussels summit would find ways to ensure the EFSF is used “effectively” to withstand the threat of a “credit event”, or sovereign debt default, in one of the weaker countries. But Merkel is still adamantly opposed to the idea of leveraging up the EFSF via the European Central Bank, though this is precisely what the French government has been agitating for. Having said that, Berlin and Paris seem to be reaching agreement that Europe’s banks should be recapitalised to meet the 9% capital ratio that the European Banking Authority is demanding. We are also hearing that the overall recapitalisation required will be closer to €100 billion rather than the €200 billion recently mentioned by Lagarde - the bazooka seems to be getting smaller. French and German banks, we are told, can meet the new capital ratio target on their own without recourse to state funds, let alone the EFSF. Other countries’ banks, however, may need financial support.
It is now being reported that Merkel expects the Brussels meeting to agree on a policy of taking legal action against countries that “flout” EU budget deficit rules - possibly in a move to ameliorate the disgruntled banks, which have hypocritically moaned about the ‘feckless’ behaviour of countries like Greece, Portugal, Ireland, etc.[2]
Perhaps putting the cat among the pigeons, Jacques Delors, former EU president (along with three other prominent European economists), has argued that in order to restore confidence it is necessary to have a “financial surge” of Eurobonds issued by the EFSF in the short term, and after that “union bonds” issued by the European Investment Bank.[3] Thus equipped with tools “offering real protection against speculative attacks”, Delors maintains, the EU will have issued a “dual signal”, whose “clarity and breadth appear to be the only factors capable of restoring confidence and dynamism in these difficult times”. Needless to say, for the current German government the very idea of Eurobonds - let alone “union bonds” - is anathema.
Bankruptcy
As for Greece, it has been convulsed by a 48-hour general strike on October 19-20, with virtually every sector of the economy affected. Public and private sector workers are marching together and encouragingly, for the first time, small business owners and shopkeepers are taking part - all out, Greek-style. The strike is timed to coincide with a parliamentary vote on two bills that outline a regime of yet more tax hikes, pay cuts and job losses - as demanded by the EU and the IMF. Get more blood out of the stone.
George Papandreou’s ruling Pasok party has a four-seat majority, but some of his backbenchers have threatened to vote against the measures - so it not beyond the bounds of possibility that his government could fall, sending the euro zone into further crisis. Meanwhile, Greece has yet to receive its next tranche of €8 billion in bailout money and is due to run out of cash by November 10 - meaning that the government will be unable to pay public sector wages and pensions, run trains, collect rubbish, bury the dead, print school text books, etc.
But try telling that to the EU, IMF and ECB troika. By all accounts, its ‘debt inspectors’ are becoming increasingly exasperated by Athens’ failure to implement the economic and structural ‘reforms’ deemed necessary - not enough pain; therefore no cash. Merkel is even considering, it seems, setting up a permanent team of international lenders in Greece to monitor its debts on virtually an hour-by-hour basis - talk about humiliation. But the long and the short of it is that Greece is only days away from bankruptcy and default. The besieged Papandreou hit out at the troika, and the euro zone leaders as a whole, for their failure to come up with a “viable solution” to the debt crisis - bitterly complaining that Greece is “not Atlas who can bear all of Europe’s problems on its shoulders” - “not even Germany” could do that.
Without the clear emergence of a “comprehensive plan” on October 23, the markets could plunge in despair - in which case, November 3-4 could be too late. Moody’s warned on October 17 that in the next three months it might deliver a “negative” verdict on France’s credit rating, meaning that the country could lose its triple-A status. In the opinion of Moody’s, the “deterioration in debt metrics” and the “potential for further contingent liabilities to emerge” - like a significant increase in its contribution to the EFSF or having to bail out one or more of its own ailing banks - are all factors that threaten the “stable outlook” of the government’s debt rating: the country just has less financial leg-room than it did during the financial crisis of 2008-09. And what is true for France could well apply to other countries - such as the UK, most obviously.
Forebodingly, a few days before, BNP Paribas - France’s biggest bank - was downgraded by S&P because of its “weakening financial profile”. Concretely, the difference between France’s borrowing costs and those of Germany is set to reach the highest level since 1995 - an ominous indicator as to the extreme ill-health of the euro zone project. Of course, S&P further downgraded Spain’s credit rating by one more notch on October 13, citing “increasingly unpredictable financing conditions” that could squeeze a private sector already pressured by struggling economic growth. Similarly, on October 18 S&P downgraded 24 Italian banks and financial institutions, explaining that “renewed market tensions” in the euro zone’s periphery - and the overall “dimming” of growth prospects for the EU as a whole - have led to a further worsening in the “operating environment” for Italian banks.
Next in the credit firing line could be the UK. A recent report by Legal and General Investment Management declared that Britain’s credit rating is “likely to be reviewed in the coming years”, as it becomes obvious that the government will miss its growth forecasts by a wide margin and hence runs the danger of falling back into recession.[4] Rubbing salt into chancellor George Osborne’s wound, LGIM expects the country’s debt-to-GDP ratio to remain on an “explosive path” and believes that it is impossible for the government to meet its growth targets for the simple reason that this would require the “biggest private sector boom ever” - in order to compensate for the largest fiscal squeeze since World War II, the private sector will have to grow “not just at its fastest rate in one year, but for four in a row”. Now how likely is that?
Notes
1. The Daily Telegraph August 8.
2. Reuters, October 18.
3. The Guardian October 18.
4. The Daily Telegraph October 12.