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Winnipeg Free Press - PRINT EDITION

Optimism from summit not the same as results

By: Satyajit Das

Posted: 07/14/2012 1:00 AM | Comments: 0

Despite an "encouraging" eurozone leaders' summit and a 0.25 per cent interest rate cut by the European Central Bank (ECB), significant uncertainties remain. The proposals are vague and details sketchy.

After the meeting, German Chancellor Angela Merkel told the Bundestag "differing communications" from various eurozone leaders about the exact agreement had "led to a whole number of misunderstandings." Spain and Italy's gleeful boasts of unconditional aid do not square with Dutch and Finnish insistence that any money would require compliance with strict conditions. Finland is insisting any aid have priority over commercial lenders.

The initiatives may require complex and time-consuming changes in European treaties.

The German Constitutional Court must also rule on some aspects of the current proposal. In short, implementation risks remain.

Importantly, there was no commitment of new money of any kind. Since mid-2011, Germany has resisted any increase in the size of existing bailout facilities.

The ability of the EU to support the peripheral nations on an ongoing basis is suspect.

The 440 billion euros of the European Financial Stability Facility (EFSF) are largely committed to the Greek, Irish and Portuguese bailouts as well as the 100 billion euros required for Spanish banks. When the new European Stability Mechanism is fully operational, there will be 500 billion euros available. Potential requirements include a third bailout for Greece and further assistance for Ireland and Portugal. Additional money for recapitalizing European banks, especially Spanish banks, may be needed. Spain and Italy have financing requirements of around 600 billion euros in the period to 2014, mainly to pay maturing debt.

This also assumes the EFSF (which is backed by guarantees from eurozone members including Spain and Italy) and the ESM (which will require capital contributions totalling 80 billion euros from all eurozone members) can issue any required debt to finance its activities.

Support from the International Monetary Fund (IMF) is uncertain. The lack of conditions and supervision of loans may complicate IMF participation.

Domestic politics within the United States in a presidential election year may also limit flexibility.

The monetary arithmetic of European debt problems remains highly problematic. The EU may simply not have enough funds to carry out its programs unless the bailout funds are increased in some way or the ECB follows the U.S., U.K. and Japan into full-scale quantitative easing to monetize European sovereign debt.

The June summit also highlighted deep fissures within the eurozone itself. Germany, which is expected to pay substantially to solve the European debt problems, finds itself increasingly vilified and isolated. At the same time, the German chancellor faces increasing domestic criticism for providing assistance without extracting agreement to suitable tough conditions from recipients.

Germany's willingness to continue to finance the existence of the eurozone cannot be taken for granted. Merkel has increasingly emphasized Germany's financial strength is not infinite. Facing complex domestic political pressures, Finland and the Netherlands remain equivocal.

Despite progress, European leaders refuse to acknowledge that a portion of the debt of the peripheral nations is unrecoverable. None of the steps announced improves the sustainability of the debt levels of the affected countries, their access to markets or cost of borrowing in the medium to long term. Ultimately, it is not possible to solve the problem of excessive indebtedness with more debt or by simply changing the lender.

Austerity dooms Europe to a prolonged, contained depression as the debt burden is worked off. The alternative, a debt writeoff, would result in significant loss of wealth for the mainly European lenders and investors, triggering an economic contraction and a prolonged period of economic stagnation.

The eurozone has managed to avoid a life-threatening emergency, converting its condition to that of a chronic disease requiring constant medical management. Treatment options available are now limited. The strategy is palliative care, hoping for the miracle of growth in Europe and the global economy.

For the moment, investors and the non-German members of the eurozone are celebrating. It would be wise to remember American writer Edgar Howe's observation: "There is nothing so well-known as that we should not expect something for nothing -- but we all do and call it hope."

Satyajit Das is author of Traders, Guns & Money and Extreme Money, and a consultant to Jory Capital.

Today: The eurozone's chronic disease

Next: Germany can't save the eurozone

Republished from the Winnipeg Free Press print edition July 14, 2012 B17

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