Opinion

James Saft

‘BRICaid’ for Europe a busted flush

September 15, 2011

James Saft is a Reuters columnist. The opinions expressed are his own.

HUNTSVILLE, Ala. — Don’t count on the euro zone getting a leg up from the giants of the emerging markets.

The idea that Brazil, Russia, India and China will use some of their massive foreign reserves to buy up the bonds of weak euro zone countries has a certain symmetry, but it is unlikely to happen and even more unlikely to work if it does.

Brazilian Finance Minister Guido Mantega on Tuesday confirmed that the so-called BRIC nations will discuss help for Europe when they meet next week in Washington in the run-up to the IMF meeting on Sept. 24.

The idea, which is internally consistent at least, is that the exporting BRICs can save themselves pain if they step in where private investors are unwilling to and help to stave off a monetary union and banking crisis.

While you can bet the BRICs will use this possibility as a bargaining chip, as well they should, this is a crisis of insufficient global demand and too much debt and this particular maneuver will do little to nothing to address those issues.

So far, only Brazil is indicating much enthusiasm for the idea. India was lukewarm, Russia pointed out that its reserves already include more than $250 billion of euro-denominated securities, giving it little headroom, and China managed to at the same time both pass the buck and plead for better trade status.

The BRICs are unlikely to bail out Italy, or Germany depending on how you view things, for many of the same reasons the Europeans seem unable to help themselves: self-interest and domestic political exigencies are trumping cooperation and the hope of a better overall outcome.

China and Russia are, with good reason, very concerned not just with what a euro explosion will do to demand for their exports, but also with the risk that they will see their own treasure wasted in a possibly futile attempt to bolster a system that is unable to take the decisions needed to ensure its own survival.

“We would like to know what actions will the European Union take itself, what scenario will they opt for: a default on Greek debt, default or no default? Whom will they help: banks or governments?” Arkady Dvorkovich, President Dmitry Medvedev’s chief economic adviser, told Reuters on Wednesday.

TREATING THE WRONG ILLNESS

As well, even though massive purchases of peripheral euro zone bonds may buy time for a solution to the essentially political issue of euro zone fiscal management, they could turn Europe from a capital exporter into a capital importer, turning its small trade surplus into a deficit.

“This means slower growth for Europe — Germany needs a trade surplus to generate growth and Spain’s trade deficit is so high that it cannot afford any further deterioration,” according to Michael Pettis, a professor at Peking University.

“Is it really a good idea to trade slower growth for another year or two in which Europe can further build up its debt burden?”

This is exactly the point: Europe needs to destroy its debts rather than build them up. This can be done through some form of default, or call it a jubilee if you like, or through inflation. More extending and pretending with the help of less well-off nations won’t address this, especially as it will only serve to make possible more programs of austerity in Europe. These will cut growth and make the debts that much more unwieldy.

Jerome Booth, Head of Research at Ashmore Investment Management, points out that the “BRICaid” idea, as he calls it, has things almost exactly back to front.

“The best way emerging markets can help developed countries is by boosting global aggregate demand,” he writes in a note to clients.

“The way to do this in a noninflationary way is through a massive set of infrastructure projects in emerging markets amounting to several trillion dollars. EU and U.S. funds should be encouraged to participate and could also help increase transparency and reduce inefficiencies. This appears not to be up for discussion though.”

What remains is for the euro zone to clearly define whom it is going to help, why and how. The best option might be a massive recapitalization of banks and a writedown of the debts of the bad borrowers, combined almost certainly with taking a number of banks into public administration.

The problem is that since the euro zone cannot seem to be able to agree to do this collectively, with Germany footing much of the bill, it may end up doing it individually, a process that almost certainly implies the currency zone will not survive in its current form.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

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