A painful holiday’s end for Europe

August 24, 2010

Europe’s long summer holiday still has a week to run but this year’s reentry will bring with it evidence that very little progress has been made on the issues that threaten to rend the currency union and upend the global economy.

Despite waving the stress-test magic wand over its banks in late July the same problems continue to grow unchecked: a euro zone periphery that can’t compete, may not be able to pay its debts and so may bring down with them the very banks that have been pronounced healthy.

While the German economy is growing at a rate not seen since the Berlin Wall came down, things are a good bit worse in Ireland, Portugal, Spain, Italy and especially Greece, all of which face some combination of an austerity-induced recession and debts public and private which which threaten their banking systems, local governments and Treasuries.

Investors have looked at this on the one hand and on the other a $1 trillion bailout, a pliant International Monetary Fund and the results of the stress tests and have voted with their feet: average spreads between German and peripheral country bonds are back in territory last seen in June and heading north. Ten-year Greek bonds now yield 861 basis points more than German issues, or about where they were in May when we were all debating the chances of the euro surviving in its current form.

Irish bonds too have underperformed alarmingly as austerity without debt rescheduling does what austerity without debt rescheduling does: kills growth and kills the prices of assets the debts are secured upon, leaving the country less able to service its debts and more likely to default even harder. Yes, defaults are like sneezes; some are polite and soft and some splatter everyone in the room.

A number of interlocking stories show that, while European central bankers are talking a firm game about upgrading growth forecasts on the back of German exports, their actions show continued very strong concern.

First comes news on Monday that Anglo Irish Bank has transferred a new batch of impaired loans to the state-run bad bank National Asset Management Agency at just 38.1 percent of their face value, a price lower than the last transfer and one that, while it may prove optimistic, even at this level implies a weakening asset market and a growing and perhaps ultimately un-meetable bill for the government. Remember, the more money Ireland needs from the center, the less there is available to meet the growing needs of Greece and Spain.

Shortly after came news that the European Central Bank last week bought 338 million euros of bonds, the most since early July. This follows closely on talk, unsubstantiated, last week among bond market participants that the ECB had bought up 60 billion euros of Irish bonds as investors lost confidence in Ireland and sold.


All of this put dovish comments by Axel Weber, Bundesbank President and a hawk’s hawk, in perspective. Weber told Bloomberg Television on Friday that it was “wise” to extend unlimited lending to banks through the volatile end of year period, effectively moving the conversation about exiting some of its support of the market and of banks back to 2011.

That was not far from market consensus, but coming out of Weber’s usually tough-talking mouth unexpectedly on a summer’s Friday suggests that things in the banking system in Germany are not stable and will require continued support.

Spain too is a huge source of concern: as of June its banks have borrowed 126 billion euros from the ECB, up nearly half from May, money they need because many are shut out of interbank funding markets and have amassed huge portfolios of real estate which they hope will somehow rise rather than fall in value.

Surveys of purchasing managers released on Monday only underscored the divide between the robust center and the struggling edges; Germany and France are doing pretty well but there are no signs that austerity is bringing with it a rapid growth in competitiveness for the hindmost.

This is the problem: Europe cannot support its banks, honor all its debts, increase the competitiveness of the weak and hold on to a common currency all at the same time. This is not a problem that market confidence can solve, even if market confidence can be generated.

Like the United States, Europe has decided that the banks won’t be allowed to fail and has reasoned outward from there, a debts over people, or taxpayers if you like, strategy.

Welcome back, policymakers, you have an interesting autumn ahead.

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