Saturday, December 10, 2011

The Eurocrisis – A Gallic snub, No Haircuts & More Stability Funds

What a dramatic few days we have just lived through!  The grandest experiment in modern history – the European Union – has weathered a major threat to its existence, with 27 governments gathering in Brussels, and 26 agreeing on a roadmap for future stability and closer fiscal union.

And the one country that is half-in and half-out of the Union smacking down its veto to prevent a full treaty incorporating terms the other 26 have agreed upon, and walking off in a huff, hoping it has protected its major industry.

Cameron's fight to save the City's role:

David Cameron tried to save London's position as the pre-eminent financial centre (some 80% of all financial transactions flow through the City); he gambled on the veto stopping any erosion of the City's clout, and returned home hoping he had achieved this aim.

But he has failed to save London.

The chances are very high that Cameron will be back at the table, prepared to accept restrictions on the flow of funds in the form of new capital requirements on banks, and a financial transaction tax (a variant of the famous Tobin tax, whose time has come at last).

But if Cameron is wise, he will pick up some of The Cat's suggestions set out below in order to ensure that the financial transaction tax is a worldwide one. London's fear is that if the financial transactions tax is applied only in the EU, then dealers will flee to places (like the USA) where the tax does not apply, and the bulk of financial business will move from London to New York.   
Cameron approaches Sarkozy ...

This is a valid fear,  but Cameron can overcome it with The Cat's ideas, provided the UK PM gets another set of advisors (his current lot blew it big time in Brussels).

Sarkozy snubs Cameron – the handshake avoidance waltz:

A video shows Cameron approaching Sarkozy, hand outstretched, Sarkozy weaving to one side and ignoring the proffered hand, and Cameron standing crestfallen as the French President steps off to the side.  This is the Daily Mail report (my redlining and bolding):

Mr Sarkozy laid the blame for the failure squarely at Mr Cameron's feet. Speaking shortly before dawn, after what he called a 'difficult' night, he said: 'David Cameron made a proposal that seemed to us unacceptable, a protocol to the treaty that would have exonerated the United Kingdom from a great number of financial service regulations.'

Mr Cameron defended his stance. 'What was on offer is not in Britain's interest so I didn't agree to it,' he told reporters in Brussels.
Sarkoy swerves ...

What did the 26 decide in Brussels?

Here's a short summary of the major decisions, from BBC News, and here is the completed document they signed in the early morning:

EU leaders aim to have the pact - known as a "fiscal compact" - ready to take effect by March.
Its main provisions include:
  • a cap of 0.5% of GDP on countries' annual structural deficits
  • "automatic consequences" for countries whose public deficit exceeds 3% of GDP
  • the tighter rules to be enshrined in countries' constitutions
  • the EU's permanent bailout facility, the European Stability Mechanism (ESM), to be accelerated and brought into force in July 2012
  • the adequacy of 500bn-euro (£427bn; $666bn) limit for the ESM to be reassessed
  • eurozone and other EU countries to provide up to 200bn euros to the International Monetary Fund (IMF) to help debt-stricken eurozone members.
No More Haircuts:

Sarkozy managed to back Merkel off of her crusade to punish those who had made bad decisions by investing in the bonds of governments that were now unable to repay the full amounts they owed.
A crestfallen Cameron ...

She had insisted that the private sector banks that had bought Greek government bonds take a loss – known in the trade as a haircut – before Germany would lend money to save Greece. She was offered a 20% haircut but stood her ground, and finally agreed to a 50% haircut. Her principle was that sinners should be punished.

Now she has agreed in the Brussels deal that there will not be a requirement for banks to take haircuts in future rescue operations of Eurozone countries:

We clearly reaffirm that the decisions taken on 21 July and 26/27 October concerning Greek debt are unique and exceptional; standardised and identical Collective Action Clauses will be included, in such a way as to preserve market liquidity, in the terms and conditions of all new euro government bonds.

The Next Steps:

A key element for Chancellor Merkel over the past 2 years has been the order in which steps are taken to solve the government debt crisis.

She has insisted on a step by step process, first dealing with the fiscal problems through agreement between the Eurozone governments, before considering any rescue operations of faltering governments by the European Central Bank (ECB), the IMF, or some new fangled joint guarantee of Eurozone debt by all the governments (read: piggybacking on Germany's wealth to save the spendthrift sisters) through the issue of a joing eurobond. She insisted on having something tangible on the table.

For Merkel, it was essential that the horse be put before the cart, and in her mind she clearly knew what was the horse and what was the cart. Fix the system first then fix the individual countries. 

This was something that the Obama administration failed to do – he jumped in to rescue the banks with his TARP (Toxic Assets Repurchase Program) but then failed to fix the systemic problems (no Volcker solution, no reinstatement of the Glass-Steagall Act to remove temptation by separating investment banking from commercial banking, no removal of rewards for greed by controlling obscene bank officers bonuses, not right regulation of derivatives, no tax on financial transactions to damp down predatory currency speculation ...the list goes on and on).

Now Merkel is prepared to consider beefing up the new Financial Stability Mechanism (FSM), by considering whether an increase is needed in mid-2012:

We will reassess the adequacy of the overall ceiling of the EFSF/ESM of EUR 500 billion (USD 670 billion) in March 2012.

Cameron's team had repeatedly parrotted the witless American suggestion that the EU use a massive amount of committed funds to reassure the skittish markets that all European banks would have access to funds – a solution termed the bazooka.

Now Merkel is prepared to consider her variant of the bazooka – but it will be a Eurozooka, designed in Berlin, with tight controls, and accompanied by a raft of new regulations to remove gambling from the banking systems of Europe.

Methinks her approach will succeed.

The Lean Years:

What is clear is that the EU faces five to ten lean years, with slow growth, a recession, massive unemployment in the 10% plus range for the weakers sisters, major painful structural changes as the weaker sisters are forced by the Brussels deal of September 9 to move their economies away from state controlled activities similar to those used in China, to a more efficient mixed economy.

However, notwithstanding all the doomsday sayers, what happened in Brussels was the essential first step. Other steps will come, and Europe will be far better off for future shocks than America is.

And a lot of the credit will go to the unlikely partnership of Sarkozy and Merkel.

Comes the time, comes the man.

Europe is lucky to have such people at the helm right now. American is unfortunate that it does not.

A Picture of the Future:

Try your hand at picking the likely outcome of the Eurocrisis, using the BBC interactive diagram you can find here



I believe the correct option is the Union option, which is this:

Union - The European Union turns into a political federation
As the financial malaise keeps doggedly returning, so the eurozone governments call more and more summits and come up with more and more proposals for closer union.
Eventually they agree a complete political union - a democratically-elected government in Brussels that can borrow with the backing of all 17 member countries, and can spend money wherever needed - rescuing banks, paying unemployment benefits, financing investment in the more recession-mired countries. The UK and other EU countries not signed up to joining the euro are asked to exit the EU altogether and join a looser free trade area, with much less political influence.

Now you try it!

The Cat's London Solution:
Cameron should table a revised financial transactions tax, which will avoid his fear of leakage from London to other centres. This Cameron-Tobin Tax would tax financial transactions entered into by any member of a bank's family, no matter where the transaction takes place. It will have extra-territorial effect as a result. So if any bank now trading in London tries to avoid the tax by moving its trading book to, say, New York, and have the trading done by a subsidiary in New York (where there is no such tax), then the EU will nevertheless impose the tax on all relatives of that trading company which are doing business in the EU, and so recover the tax.

In essence, the trading sins of a family member will be paid for by the family; a form of collective taxation that Americans are familiar with under their tax system.

This will discourage a flight from London and the EU, especially of a lower Cameron-Tobin Tax rate is levied on bank families which do their trading in the U.

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