Wednesday, October 26, 2011

Chancellor Brinkmanship: Angela Merkel's Teutonic discipline for the EU Latin Fringe

To some, the Eurozone crisis has all the hallmarks of a train crash. These onlookers are only partly right.

The Eurozone crisis is a slow motion train wreck, with the speed being checked as and when she wants to, by Chancellor Merkel of Germany.

The Stampeders:

On the one side, we have the capital markets, which have been hoping to stampede the EU governments into a panicstricken rush to rescue the private sector banks from their rash loans to shaky EU countries. Speed and panic are their friends; if they can make governments fear that worse will come unless the private sector banks are rescued by having their bankrupt loans bought out, then speed helps them because it gives governments less chance to think things through.

So the private sector banks float ideas that are designed once more to publicize bad debt while still privatizing profit. 

Take the illfated giant Eurobond, for instance. It was designed to be a superbond, issued with guarantees by all 17 Eurozone countries. The proceeds would be used to buy existing bonds of the spendthrift sisters (Greece, Spain, Italy) and to provide further funding for these spendthrifts.

The Woman who said No:

The woman on the other side of the divide, Chancellor Merkel, was not to be rushed.

She nixed the Eurobond because it simply amounted to a Get Out of Jail Free card for the reckless banks, while making the two big economies (Germany and France) bail out the banks and the spendthrift countries.

The Stampeders' Second Try:

It's wonderful to watch the tension between The Stampeders and The Woman Who Says No. The banks get the idiotic press onside with huge headlines and great sound bytes; Sarkozy does his patented headless chicken dance; and then everyone shuts up and listens to The Woman Who Says No.
The Old Testament Chancellor

The banks then suggested a new vehicle could rescue them. They did not put it that way, of course, but spoke about 'ensuring stability in the capital markets', as if the capital markets are some huge unseen and depersonalized immutable force of history. If Germany and France would not guarantee the loans, then perhaps this New Vehicle could do that by bypassing these governments and solving the problem – the strong governments could backstop the vehicle, which might make it more palatable for their citizens.

They had a fancy name for the New Vehicle, the European Financial Stability Facility (EFSF):

Originally, the idea was to massively increased in size, from 440bn euros ($595bn; £383bn) to about 2tn euros.

A fund of this size should be able to deal with the huge economies of Spain and Italy. However, simply scaling up the size of the fund is not politically feasible, as this would involve increasing the size of the guarantees provided by the member governments. And that is something that many governments, including Germany's, would find impossible to explain to their voters.

Another option, favoured by France, involved getting the fund to borrow additional money from the European Central Bank. But the idea was strongly resisted by the ECB itself, and has now been blocked by Germany.

This idea bit the dust because Merkel hunkered down and said No.

She's an Old Testament Kind of Girl:

Why is she being so firm on what can and cannot be done?

The answer is very simple. She believes that finance is more of an Old Testament type of environment, then a New Testament, forgive the sinner and turn the other cheek, kind of world.

For Merkel, borrowing is governed by stern  laws of Old Testament strength. An eye for an eye, and a tooth for a tooth.

And sinners must not only pay for past sins, but must be forced to reform their sinning habits, even if they don't want to do so.

And for the Chancellor there are three sets of sinners in this mess: the spendthrift countries, the reckless banks, and the weaklings (like Sarkozy) who are prepared to be stampeded and do what they are told.

So Merkel slows things down. Hits the brakes of the runaway train. Calls the bluff of the sinners.

And demands a pound of flesh for any help to be given.

Take the option she is forcing the EU to consider:

One option still being considered is for the EFSF to provide guarantees when countries such as Italy or Spain need to borrow more money.

The guarantee would only cover the first 20%-30% of any debt write-off by these governments.  By limiting the guarantee in this way, it means the 440bn euros will stretch much further. But it also means that if a government did default on its guaranteed debts, then the EFSF - which in turn means German and other taxpayers - could stand to lose all of the money that it guaranteed.

The limited guarantee is a far cry from the full guarantees of the Eurobond the "market" wanted.

Sinners Must Pay:

And Merkel is demanding that the reckless banks pay a price – they must write off 50% or more of their shaky loans.

This means they have to raise more capital, or go bankrupt. Her solution for that is for the banks to be forced to raise new capital (so that they can leverage  the capital for new loans, while also absorbing losses from the writedowns), and be helped by their own governments if they can't raise enough and only then by some form of supranational help.

And, of course, she has tabled the need to change the terms of the EU treaty so that discipline in economic and financial matters can be forced upon future spendthrift nations, by the stronger ones. This the price sinful spendthrifts have to pay, in her eyes, and it is the price for her to step forward and help to fix the mess.

The Simple Questions you should ask:

These details are complicated, but the essence is discernible, if you ask some simple questions.

For example, who is in a hurry? 

The reckless banks are; the spendthrift nations are; France is moving this way and that, wishing the problem would go away so that Sarkozy can start organizing the downfall of the Syrian dictatorship. Merkel is not in a hurry. She will take her time and work patiently through things.

Another example, who loses and who gains? 

If shareholders of banks are to gain while the strong nations lose through guarantees or loans or some other nonsensical solutions, who will agree to that? While the jury is still out on what share of the banks' restructured capital the taxpayers of their countries should  own (through their governments), it is possible that in Germany the German taxpayers will actually get some of upside when the system stabilizes in return for taking losses now to restore calm: something the Obama Administration signally failed to achieve for the American taxpayers in return for their massive bank bailouts.

And the final question, were sinners punished?

If you spot punishment woven into the mix of solutions, then you are probably witnessing stern Teutonic justice being levied on spendthrift Latin governments and taxpayers.

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