20.06.2012
High noon for the euro
The G20 summit has seen desperate, last-minute moves to prevent debt catastrophe engulfing Spain and Italy, writes Eddie Ford. But is it just more rhetoric?
Once it became apparent that ‘pro-bailout’ New Democracy had beaten the anti-bailout Syriza in the June 17 Greek parliamentary elections, albeit by an uncomfortably small margin, the international bourgeoisie gasped in relief. The prospect of a very messy Greek exit from the euro seemed to have receded.
But, regardless of the political horse-trading that has been taking place in Athens, the same essential underlying problems remain. For example, in the two weeks prior to the election, some €4 billion was withdrawn from Greek banks by panic-stricken investors and ordinary depositors - on top of the estimated €20 billion that took flight following the May 6 election (though in reality the rich ‘unpatriotically’, but sensibly, took all their money out a long time ago). Unemployment has jumped to 22.6% from 20.7% at the end of 2011. According to Giorgos Zanias, the finance minister in the caretaker government, the country has enough cash to survive until July 15 - then what?
Slightly frighteningly, the Open Europe think-tank estimates that the European Union countries have a total exposure of €552 billion to the toxic Greek economy - quite a sum. Unsurprisingly then, many think that Greece will have to ask for a third bailout - or at least some sort of substantial cash injection - within the relatively near future: not to do so could put Spanish, Italian and French banks in the firing line. No surprise then, the Merkel administration in Germany is under extraordinary pressure to relax the fiscal targets previously laid down by the European Commission, International Monetary Fund and European Central Bank troika. Nonetheless, Berlin is still insisting that now is not the time to be giving “discounts” to Greece, not least because to do so would place the main burden for saving the world economy from disaster on Germany.
So, yes, the Eurocrats might have got the election result they wanted in Greece. Yet it could well turn out to be a Pyrrhic victory, promoting the dangerous illusion that the Greek establishment - and the Eurocracy as a whole - can somehow muddle through. The money will be found. ‘Responsible’ governments will navigate the stormy waters. Unfortunately for them, however, the European sovereign debt crisis refuses to go away. In fact, if anything, it looks set to escalate.
Critical
Proof positive of this was dramatically displayed by the market ‘rally’ that we saw on the morning of June 18, which lasted less than two hours. Then reality intervened, as it always does, with the markets gripped by a persistent suspicion - and fear - about the condition of the global economy and the financial health of the other euro zone countries.
Markets were also rattled by the news that the full audit of the Spanish banks commissioned by the government of Mariano Rajoy has been delayed until September on the grounds that it needs more time to “gather information”. What on? The ever deteriorating non-performing loan figures? Nor did it particularly help, from the viewpoint of general psychological well-being, that Germany’s constitutional court upheld a complaint by the Green Party against the ESM - ruling that Angela Merkel’s government had not consulted parliament “sufficiently” about the exact configuration and remit of the new body due to replace the EFSF in July (the court judgement will have no practical effect or consequences, of course).
Hence confidence in Spanish government bonds slipped yet further, yields nudging up to the unsustainable pre-June 17 levels, almost as if the Greek election had never happened. By the afternoon, the yields on 10-year bonds (effectively the interest rate on government IOUs) was back over the 7% mark - reaching at one point a potentially crippling 7.26%, a new euro-era high. Next day the rate hovered around the 7.1% point, dipping ever so slightly to 6.96% the following morning, but then rising to 6.99% as the day progressed. Inevitably, the yield on Italy’s 10-year bonds also started to rise in a perverse display of market solidarity, bouncing around between 6.04% and 6.1%, then mildly improving to around 5.87%. But still far too high.
Spain’s perilous position was also highlighted by the two debt auctions that were held on June 19 - definitely a tale of two countries. Denmark sold 1.6 billion krone (€215 million) of debt maturing in 2014 at a negative bond yield of -0.08%, compared to the average yield of 0.31% at the last auction - meaning that investors are essentially paying the country to lend it money. Spain, by contrast, sold €640 million of 18-month bills with an average yield of 5.1%, as opposed to 3.3% at the last auction - additionally it sold €2.4 billion-worth of 12-month bills at an average yield of 5.07%, compared with 2.98% at the last auction. Not that Italy fared much better, selling three-year bonds at an interest rate of 5.3%, sharply up from the 3.91% paid at a similar sale a month ago.
Speculators are prepared to buy Danish bonds with a negative yield for a simple reason: in the event of a euro break-up, and in view of the fact that the krone is pegged to the euro, they are envisaging a tidy little profit. Or, to put it another way, they are desperately seeking a relatively safe home for their money, given the paucity of attractive-looking investments.
To really paint things black, Spanish banks’ bad loans ratio rose to 8.72% in April from 8.37% in March, the highest since April 1994. Lending declined to 3.5% in April from last year and deposits fell 5.39%, whilst the mortgage default ratio climbed from 2.4% in December to 3.01% in March. Furthermore, Spanish banks borrowed a record €324.6 billion from the ECB in May, up from the €319.9 billion in April - making them by far the biggest users of ECB funding, accounting for about 30% of the latter’s outstanding liquidity (having said that, as we would not want to be unfair to the Spanish bourgeoisie, it is important to remember that the banks in the other ‘bailout countries’ are even more reliant on ECB largesse). Obviously, this data casts extreme doubt over the proposed €100 billion bailout - apologies, “credit line” - for Spain supposedly agreed to much fanfare on June 9. Will it be anywhere near enough? And, indeed, the ING banking group has calculated that Spain may in the end need a €250 billion bailout - although the Bank of America thinks that is understating things: it estimates that some €450 billion may be needed to see Spain through the next three years or so.
No wonder that Cristóbal Montoro, the economy minister, warned that the country was now in a “critical” condition and pleaded with the ECB to act with “full force” in order to fight off the attacks beating down daily on Spain and the euro zone as a whole. Ill-omens are everywhere. On June 14 Moody’s rating agency slashed Spain’s credit status to just one notch above ‘junk’ - arguing, quite logically, that the June 9 plan to recapitalise Spain’s banks would merely increase the debt burden, and this in a country whose GDP is contracting, not growing. Meaning that Moody’s might reduce Spain’s rating again within the next three months - perhaps much sooner. If that were to happen, some index-tracking investors would be forced to sell off their bonds. That would, of course, straightaway add to the pressure on yields and force Spain’s overall financing costs up higher - thereby further necessitating a full-blown (or second) bailout. A vicious cycle.
While we have yet to see the ECB move into decisive action, despite Montoro’s imploring, the Swiss National Bank - to name one formidable financial institution - issued a stern statement on June 14: it “will not tolerate” any further appreciation in the value of the Swiss franc, which has become a major safe heaven for investors, as they dump risky Spanish or Italian bonds. A wildly over-valued franc, continued the statement, would have a “serious impact” on both prices and the economy in Switzerland - ie, its export industries would suffer massively. Therefore the SNB will enforce with the “utmost determination” the minimum exchange rate of 1.20 francs per euro and is prepared, if push comes to shove, to buy up foreign currency in “unlimited quantities” for this purpose.
Naturally, all eyes turned to the G20 summit held over June 18-19 in the luxury resort of Los Cabos, Mexico. Surely the world leaders could not keep on kicking the battered can down the road: something had to be done. The press was alive with rumours that some sort of bold action was being planned, once again raising expectations that governmental leaders had awoken from their slumber and were going to tackle the crisis. A new fiscal Marshall plan or perhaps even direct ECB intervention to rescue ailing European banks?
Rather unexcitedly, however, a draft communiqué issued on the first day of the summit talked about taking “all necessary measures” to hold the euro zone together and break the “feedback loop” between sovereign states and banks - but, as per usual, no details were forthcoming. The final G20 statement, due to be released on June 20, is expected to call for a “coordinated global plan” for job creation and growth, according to Reuters; and if growth falters the document will state that countries without heavy debts should “stand ready to coordinate and implement discretionary fiscal actions to support domestic demand”. Furthermore, we shall read - apparently - about the magnificent “steps towards greater fiscal and economic integration that lead to sustainable borrowing costs”, encompassing banking supervision, recapitalisation and some sort of deposit insurance scheme. Not to mention increased resources for the IMF.
Striking an upbeat note, EC president Herman Van Rompuy reassured us that at the G20 summit we saw “support and encouragement” for the euro countries and the EU as a whole - and steps to “overcome this crisis”. But how many times have we heard such talk? Similarly, a separate statement for the June 28-29 EU Brussels summit vowed grandly to “mobilise all levers and instruments”, though the details were frustratingly thin - what a surprise. Though time will tell, the Italian government has said it would push for a “semi-automatic mechanism” at Brussels - probably involving the ECB - to cap the bond yields of those member-states in serious trouble. But trying to pin down concrete details, let alone actual real money, of course, is like trying to nail jelly to the ceiling.
But almost at the very last minute, as the G20 summit came to a close, it seems there were desperate moves to prevent debt catastrophe engulfing Spain and Italy. Maybe rather prematurely, The Guardian headline proclaimed: “Germany surrenders over euro zone bailout fund”. The paper claimed that at a private meeting with Barack Obama, Merkel had agreed to allow the euro zone’s bailout fund, most generously estimated at €750 billion, to directly buy up the bonds of crisis-hit governments.
As our readers will know, Berlin has long opposed such direct funding, fearful - not without reason - that the German government, and more crucially still the German taxpayer, would end up footing the bill for the financial ‘profligacy’ of other euro countries (especially those ‘lazy’ Greeks and Portuguese). Current EU rules say that the bailout funds should not take on the risks associated with buying up the debt of a member-country unless it is part of an official EU/IMF programme. Are the rules of the German-dictated game finally changing?
If so, that is precisely the show of ‘shock and awe’ that the markets have been crying out for - mustering the collective financial fire-power of the euro zone to drive down Spain’s rampant borrowing costs below the dangerous 7% level arrived at over the last week. Berlin might be realising that it is confronted by a stark choice that can no longer be avoid or denied - support emergency action to prop up the euro zone’s fourth biggest economy or see the euro slide into the abyss, taking a good chunk of the world economy with it. And earn the opprobrium of tomorrow’s history books.
On the other hand, could it be mere summit-induced rhetoric? A Merkel spokeswoman coolly remarked that “nothing has been decided yet” although various G20 officials have strongly hinted that an announcement could be made by the euro zone in the next few days. In the same vein, a White House official confirmed the euro zone is working on a plan to unveil at the Brussels summit - here we go again - and suggested that the “framework” they are building - as “they described it to us” - amounts to a “more forceful response than they’ve contemplated to date”. Talk about damning with faint praise.
Yet, insofar as these putative ‘rescue plans’ have any reality, it is based on a fundamental contradiction or flaw. Everyone is calling on Germany to do something, but just imagine if Merkel did decide to do what many want - acceding to the creation of Eurobonds. Interests rates would then be equalised and Germany would suddenly find itself paying rates in the region of 3%-4%, as opposed to the minuscule rates it is paying now - ie, the yields on two-year German bonds recently sank to -0.012%. It would only be a matter of time before Germany started to suffer from rising unemployment, stagnation and so on - no more the European economic powerhouse.
Under those conditions, what would happen to the US and the flat-lining British economy? (Last week the UK government jointly launched with the Bank of England its so-called ‘Plan A-plus’ to stimulate the economy to the tune of £140 billion by offering money to high-street banks on the ‘condition’ that they kick-start mortgage and small business lending. As Martin Wolf acerbically asked in the Financial Times: will it work this time? His answer was this it is “unlikely”. Instead he urges the government to “prepare” a Plan B “now”.