Euro plan drives into ditch

November 8, 2011

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

The early returns on the euro rescue are as straightforward as the plan was vague: it probably isn’t going to work.Two numbers tell the tale: the 177 basis points over German debt the supposedly AAA-rated euro rescue fund was forced to pay to borrow on Monday; and 6.67 percent, the 14-year record amount Italy had to pony up to borrow for 10 years.

Neither of those numbers fit in well with the plan announced last week to recapitalize banks, bail out Greece, erect a firewall around the larger weak economies and produce credible plans for fiscal and economic reform.

Put simply, these numbers are telling us that the market and debt investors do not believe the plan will work in its current form. And little wonder, it is now just days later and Greece’s government has fallen, Italy‘s Berlusconi is under siege and the much hoped-for support from outsiders like China has failed to materialize.

When the European Financial Stability Facility (EFSF) tried to sell 3 billion euros of 10-year debt Monday it only just managed to scrape up the cash and was forced to pay much more than it has in past. In some ways this is no surprise; the rescue plan was vague about crucial details of how the EFSF would be structured and employ leverage.

Hopes that China and other emerging powerhouses would step up and support the plan have so far gone exactly nowhere.

Not only did Chinese President Hu Jintao leave France after the G20 summit without committing, the head of the country’s sovereign wealth fund went as far as to attack European ”sloth.”

“If you look at the troubles which happened in European countries, this is purely because of the accumulated troubles of the worn out welfare society,” Jin Liqun, chairman of the board of supervisors of China Investment Corp, told Al-Jazeera television in an interview.

“The labor laws induce sloth, indolence, rather than hard-working.”

As if that was not bad enough, British Prime Minister David Cameron said Monday that the G20 withheld extra commitments to the IMF because they lacked faith in the plan.

“The world sent a clear message to the euro zone at this summit: sort yourselves out and then we will help, not the other way round,” Cameron told Parliament.

“The important role of the IMF is not to support a currency system, not to support the bailout fund — it is to be there for countries in distress.”

ARAB SPRING, EUROPEAN FALL?

All of this is before we get to the high level of political instability the crisis has wrought.

Greece is pulling together a temporary technocratic government, but meanwhile, larger problems come to the foreground. While it is undoubtedly a good thing if the Arab Spring has jumped the Mediterranean and spread to Italy, the fact of Berlusconi’s weakness, welcome as it is for so many fundamental reasons, only underscores just how difficult it will be to make the moving pieces of the plan fit.

Berlusconi, under pressure to step down to clear the way for reform, refused to cooperate even as Italian borrowing costs hit critical levels. Two-year Italian yields hit a euro-era high of 6.31 percent. This is perhaps worse than the rise in 10-year yields and is very similar to what happened to other euro zone peripheral countries before they were shut out of the bond markets.

It is not clear that even the fall of Berlusconi will solve Europe‘s problems, though it may temporarily drive down Italian borrowing levels. The huge move higher in Italian rates since the bailout was announced instead indicates that Italy, seeing the deal given Greece, has less reason to resolve to reform. At the same time, Italy‘s vulnerability calls into question Europe‘s ability and willingness to make a truly huge transfer of wealth southward from Germany.

The logic is self-reinforcing: the bigger the prospective crisis, the less reason Germany has to stick with the euro and the more reason it has to stand tough against things like the suggestion that it put its gold reserves to work backing the EFSF.

Two things to watch now; the Swiss franc and signs of deposit flight out of Italy, Spain and Portugal.

Depositors in Italy, for example, have good reason to wonder if they shouldn’t hedge their bets by pulling out of banks there, on the small chance that the crisis leads to Italy‘s expulsion or Germany‘s flight. Some of that money would head for the tunnels into Switzerland, so any signs of renewed strengthening in the Swiss Franc should be closely monitored.

Europe is going to need some unaccustomed luck in coming weeks. The rest of us ought to hope it gets it, but perhaps prepare for the increasing chance that it won’t.

(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. You can email him at jamessaft@jamessaft.com).

7 comments

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Cannot believe you used that quote from the boss of China Investment Corp, “(European) labor laws induce sloth, indolence, rather than hard-working.”

Was that a sop to the eurosceptic UKIP party or just cantankerousness?

Posted by scyth3 | Report as abusive

We live through historic moments which will lead to dramatic changes. Even Dan Brown would never imagine to write a book were:

US is battling to resolve its deficit problem and insolvent banks/finance institutions/pension funds while trying to support European Union (in order to save its Money Market Mutual Funds from failing, in order to maintain its largest trading partner, and in order to stop one more Lehman event). And of course is trying to tackle the dilution of its role as the superpower.

EU is facing for the face time the ultimate question: to unite or to divorce. While at the same time tries to save its insolvent banks (which have 5 times the assets of the US banks) and in parallel faces tremendous imbalances between surplus countries and deficit countries.

China is trying to cool down the asset bubbles in order to avoid a burst. But also faces an increasingly aging population and is trying to assess its role as superpower and global lender. Meanwhile their scheme of increasing domestic demand and enlargement of the middle class is not progressing as it was planned and they face internal forces which seek change.

Israel and Palestine are still in “locked horns” position

North Korea is facing tremendous problems while the regime does not want to let go
Iran is armed and US/GCC is increasing the tensions sighting IAEA reports on nuclear weapons

MENA region is boiling following the removal of the previous regimes and the realization that there is no real alternative proposal

Turkey walks the fine line between the geopolitical partner of US/West in the region and the Islamic/Secular model leader of the Islamic World (but they forget that they are not Arabs)

Africa is raising steam (Somalia, Nigeria etc) while at the same time China has entered a colonization scheme similar to what Europe did in US and for almost similar reasons

Japan is been wounded severely by the natural disasters (which followed a lost decade of stagflation) while at the same time this event and others exposed the deeply corrupt nature of it’s political and business elite

India is stumbling while trying walking with it’s “democratic legs”, and Pakistan is not a good neighbor for them or for the Afganistan

Iraq is left on its own devices (more or less) while GCC would like to have this country positioned to keep busy Iran

The pieces are set on the chessboard. What is going to be the next move?

kostis

Posted by reuterskostas | Report as abusive

This article is right, it’s not that complicated: what we have in Western Europe and the Club Med countries is a situation where governments have to keep increasing their borrowing or otherwise the roof of the [artificially inflated] economy caves in. As the Chinese fellow is saying, this has fostered sloth and indolence.

At one point, the music is going to stop: investors will no longer accept for the government of Greece, Italy, Spain, France and even the UK to continue increasing their debts. When that happens, we will witness of the most dramatic reduction in government spending, something like three or four times what we have seen so far. So three things will then need to happen: 1) governments will have to learn to think (so they don’t get caught by things like sub-primes and the likes), 2) taxation will have to reduce, and 3) land rent will have to reduce or otherwise people would be able to live.

Posted by jerry_01 | Report as abusive

Until today I was pretty optimistic about Europe. Sure, the Greeks are liars and cheats and the Italians allow a buffoon to run their country into the ground, but the fundamentals are reasonable in the end, even the Italian ones. Now, however I feel a sense of despondency coming up seeing among governments and politicians a general lack of will to fix anything. Just look at the Greeks, doing nothing but dragging their feet and awaiting the next billions. Just look at Berlusconi, pretending to go away but pulling wool over everybody’s eyes. Half-measures everywhere else in Europe but no solution in sight. Might as well plant some cabbages, it’s going to be a long, cold winter.

Posted by Lambick | Report as abusive

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