In every good movie about bomb detonations there comes a moment when the hero needs choose between cutting the red wire or the black, or connecting wire A to point B to short circuit some device, as a timer runs down, with an alarm starting to whir.
Timer buzzing in the lead roles
This week finds Germany and France filling in the key role in deciding what gets cut and what gets connected.With the Euro, and the Eurozone economy the bomb, and the rest of the world the bystander watching on with mouths agape and knuckles white.
There aren’t that many bomb disposal movies, admittedly, but generally the theme tends to feature a key moment where the heroes can save things, acutely aware of the outcome if they get things wrong.Germany’s Chancellor Merkel and President Sarkozy of France would be feeling something of that same type of pressure this week.
Greece – Who wears the cuts and pays for the bailout? Banks – Who short circuits balance sheets in the banking system?And given there seems to be a lot of unhappy people setting fire to cars in Rome, but generally behaving better whilst still being disgruntled elsewhere, there is a sense of who gets to please these people – presumably by conjuring some sort of stimulus – who gets the chick?
Merkel and Sarkozy need to come up with something which makes sense to the markets, and keeps enough people of Europe onside to make it worthwhile.They have a week to do it and the rest of the world has their eyes upon them.And that world has fingers already half pointed at the Eurozone when it comes to allocating blame for the recession that much of it is already easing into.Canadian Finance Minister summed things up nicely at the G20 Finance Minister’s meeting.
“The risk of a recession would be increased dramatically were the Europeans to fail to accomplish goals that they’ve set for themselves,”
‘The Europeans’ and ‘That they’ve set for themselves’ are the words which resonate most loudly.US Treasury Secretary, Tim Geithner, did his best to follow the positive spin presumably prescribed by spin doctors, but still left nobody in doubt about who he thought needed to get their act together – after previously having turned up at the Eurozone financial summit to poke some chests on the subject.
“They clearly have more work to do. It’s all in the details.” – There is that word ‘they’ again. He added, “In financial crises, it is more risky to act gradually and incrementally than to act with bold force,” when the one thing the whole world basically agrees that the EU has done nothing but kick the can down the road gradually, with an otherwise admirable democratic process seeing tortuous negotiations involving 17 nations numerous summits, forums, and meetings, while onlookers have glanced increasingly nervously at their watches with a mounting sense of impatience.Some are simply holding their hands over their eyes, with the markets increasingly of that inclination when it comes to Irish, Portuguese, Spanish and Italian debt, French banks in particular, but Eurozone banks in general, and the Euro as a currency.But the comments of the US Treasury Secretary contained just a hint of menace too “Even though the world has a big stake in Europe doing this effectively, Europe itself has the strongest interest,” acknowledging that while there are certainly unhappy campers in the US, it is the EU which is in an incendiary state socially and the EU which will bear the biggest economic cost of things going mushy about now – the car burnings in Rome over the weekend coming after the London riots and burnings of the summer, and the massive demonstrations against austerity seen on the streets of Greece.
Setting the timer
At last weekend’s Berlin meeting Sarkozy and Merkel gave themselves until this coming weekend, when they should present what they referred to as a comprehensive plan for dealing with the Greek debt crisis, the unfolding debt crises in other Eurozone nations, and the implications for the EU banking system.At some point during the week they will receive a report from the Troika of the EU, ECB and IMF on how big the hole in the existing Greek bailout plan is, and how much more someone is going to need to reach into their pocket.
The barbers of the PIIGS
Private holders of Greek debt will be, and probably much more than they were in June when they were on the block for a 21% haircut.Current consensus in the market would suggest that at least 50-60% is more likely the going rate, with anything less implying that Greece could well be back looking at a further point down the track as its debt to GDP level continued to go stratospheric.The problem here is that the larger the haircut on Greek sovereign debt holders, the less likely markets will be to buy the debt of other European sovereigns – in particular, Italy and Spain, and Portugal and Ireland. The last two are small enough for the EU to bail out (as they have done for Ireland and are I the process of doing for Portugal) but the Spanish have an estimated €650 billion Euro debt out there, with the Italians a further €1.7 trillion worth.Admittedly Italians buy most Italian debt but it still isn’t a good look, even they might hold off if they thought they would get circa 50% in the event their politicians couldn’t manage the national finances.
In through the out door
This all means that the size of the haircut they give Greek debt holders, will have a significant say in the size of the EFSF they will need to conjure up if they are to ring fence Portugal, Spain, Italy etc, from the implications of a major market loss of confidence.Currently they are planning for a €440 billion EFSF – and just look at the political reception that has received – but if things go really bad then it is not likely to be enough, and, seeing as we are dealing with markets here, could easily be small enough in relation to the size it would ostensibly need to be (even given scope to leverage it up – good to see politicians talking about leverage) to encourage shorting by your more speculative types just to see if they could turn it into a profit.
Austerity and Solvency
That need comes on top of actually funding the actual Greek bailout, which is getting larger by the day because the politicians have kept kicking the can down the road.After 18 months the leaders of Europe will finally learn sometime this week that if you impose enough austerity a national economy will contract, if the economy contracts then its scope for repaying any debt will diminish, right at the same time the debt to GDP ratio heads off into deep orbit.Currently Greece is looking at circa 170% next year, and every fresh bout of austerity makes it less likely that they will go anywhere near managing it.Greece has solvency issues, not liquidity issues.Every additional bout of austerity does, however, does increase to possibilities – one that Greek citizens may take it upon themselves to start setting fire to cars or other combustibles, and two that Greek politics may buckle.If this happens it increases the likelihood of a disorderly default, and chaos in European, and probably global markets – watch for rapid strengthening of the US dollar and gold, and flight from just about everything else including the Euro, emerging markets, commodities and particularly anything related to Europe.
Banking on avoiding the disorderly
The risk of this type of meltdown would be easier if there wasn’t a strong suspicion that anything disorderly in Europe at the moment may well find their banks made of straw.French banks in particular are viewed suspiciously, with the recapitalization need of the entire EU banking system estimated at between €200 billion (IMF) and €1 trillion (Goldman Sachs).
Who pays for the bank recapitalizations are another issue which needs to be sorted out quickly.Prior to last week’s meeting the French were keen on the EFSF coming to the party, with the Germans coming to the party for the EFSF.But the Germans are pushing for national Treasuries to be the backstop.The experience of Belgian bank Dexia in recent weeks starts to provide an insight into the size of the problem – with the Belgian government coming up with €5 billion for what was a smaller (in the scheme of things) player, which was exposed as wholesale capital markets dried up on the suspicion that some of the banks playing it had large exposures to indebted Eurozone sovereigns and maybe subject to something disorderly or something involving haircuts.
That brings the quagmire back to the sovereigns.Contributing to a significantly enlarged EFSF may start to have major implications for the debt funding requirements of the currently AAA rated sovereigns in Europe, with France arguably most suspect, but other nations surely wont enjoy the experience either.More specifically it will certainly add to the aggravation felt at a national political level in many cases.
Who gets the chick?
Ultimately there is also a need for some sort of stimulus.Something to get economies moving and people off the streets being angry, and this before they get angrier.With the French and German economies at either zero growth or slowing from just above that according to 2Q GDP data this is as true for them as it is for the basket cases by the Mediterranean.It is just that nobody has any real scope for paying for it all, except maybe for the Germans – and they aren’t all that inclined if they are looking at funding much of all else that needs to be bailed out.
6 days and counting, prepare for an action packed finale as the markets ring bells, flash lights and generally go bi-polar in coming days.At best the Europeans may be able to sort out the Greek debt -banking crisis of their own volition and leave some sort of stimulus plan to the G20 meeting in November. But the problem is the G20 will not be able to stimulate in any way unless the Euro question is cleared from everyone’s threat board, and there is no guarantee they can do it.
RT Business Internet: James Blake