Euro plan drives into ditch
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.
“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.
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 email@example.com).