Eurozone: The Kitchen Sink Goes In – Now It’s All About Solvency
By Peter Boone and Simon Johnson
…This is a whole new level of global moral hazard – the result of an alliance of convenience between troubled governments in the south of Europe and the north European banks (and implicitly, north American banks) who enabled their debt habit. The Europeans promise to unveil a mechanism this week that will “prevent abuse” by borrowing countries, but it is hard to see how this would really work in Europe today.
Overall, this is our assessment:
The underlying problem in the euro zone is that Portugal, Ireland, Italy, Greece, and Spain are locked into a currency which means they are uncompetitive in trade terms while they are also running large budget deficits. To get out of this they need large wage and price cuts to restore competitiveness, and they need to make fiscal cuts to get budget balances back at sustainable levels.
Markets decided these adjustments were going to be difficult, so spreads on those countries’ debts widened (i.e., interest rates relative to German government bonds). As the rates go up, this causes local asset prices to fall, concerns over bank balance sheets increase, etc. This combination was causing an incipient run on banks. Any country with its own currency could reasonably devalue in such a situation, but this is not an option within the euro bloc.
All these problems were exacerbated by the appearance that the Germans were going to be unwilling to bail out troubled nations – and would eventually chose to bail out their own banks instead. It is this risk which is now resolved. The Germans have shown willingness to provide very large amounts of money (the 750bn euro support is probably just enough for Spain and Portugal if they got packages in line with that received by Greece) and they would obviously provide more if needed (e.g., for Italy). (Here again is the ready reckoning chart for interlinkages between indebted Europeans.)
However, the solvency issue remains. The Spanish and Portuguese have said they will now cut their budgets further, but already their forecasts were optimistic, and neither has seemed willing to admit they have severe budget problems, so we will need to watch how they implement in the near term. Greece remains simply far too indebted.
As Willem Buiter (formerly Bank of England, now at Citigroup) remarked last week, you have the greatest incentive to default when you are running a balanced primary budget (i.e., after substantial budget cuts) and still have a large government debt outstanding. His point is that the incentive structure of these programs means they will postpone a decision to default which would otherwise be rational now.
There is no discussion of Ireland, which has one of the highest deficits of all the EU nations. This is a vulnerability to the European Stabilization Mechanism – more countries will flock to its embrace….
The EU Stabilisation Plan
This post was written by Karl Whelan
The size of the funds announced in the EU deal are large enough to most likely ensure that, for a while, no EU country will fail to roll over its sovereign debt. In that sense it will most likely work. But it doesn’t change the fiscal reality.
Last week’s €110 billion Greek deal wasn’t well received by the markets because it still seemed to imply a Greek default was on the way. Last night’s announcement is being well received but then it doesn’t actually come with a concrete fiscal restructuring plan for Portugal, Spain or Ireland, so the plan can be taken good news without having to question any dubious underlying assumptions about fiscal sustainability. If the time comes when this fund is tapped but the markets don’t buy the stabilisation plan announced, the situation could unravel again.
Money 1: People 0
EU financial crisis – live blog | Business | guardian.co.uk .
There’s gushing enthusiasm for the Euro bail out:
With an hour to go until trading begins on Wall Street, investors are expecting a very healthy start. The futures market indicates that theDow Jones index will jump 3.4% (to around 10,685 points) while the S&P 500 could rise over 4.2% at the open.
European markets are still on track to record strong gains today, with theFTSE 100 up 4.6% at 5359 (a rise of 236 points), the German Dax is 4.7% higher , while the French CAC is having the best performance of the major indices – up 8.3%.
So the wealthy are to get their state subsidy.
But any mention of saving the agony of the Greek epople who are going top suffer cuts likely to drive demicracy from their country?
Not a bit.
Sickening.
