Technocrats can’t cure the contagion
James Saft is a Reuters columnist. The opinions expressed are his own.
Now it is Spain.
The message from markets is not so much that Italy is too big to fail but that Greece will fail and in doing so ensnare others.
The prospect of two new avowedly technocratic governments and fresh pledges and plans for austerity proved not enough to stem contagion in the euro zone, as the financing drought spread beyond Greece and Italy to Spain. Spanish 10-year bond yields climbed above 6 percent for the first time since early August when the European Central Bank waded into bond markets in Spain’s support.
Perhaps that is because the contagion isn’t coming from Athens or Rome but from governments in Berlin, Paris and the ECB in Frankfurt, all of which seem unwilling to take the needed steps to save the euro.
The era of good feeling following Silvio Berlusconi’s resignation and the appointment of former European Commissioner Mario Monti as premier-designate was, well, short. While Italian bond yields are well below the mid-7-percent levels of last week, they rose again on Monday to 6.67 percent and Italy was forced to pay a euro-era record to sell five-year bonds.
It didn’t stop there, with the costs to insure French and Belgian bonds against default also rising to a euro-era high.
With the ECB still acting as if it would fight the last war to the death while remaining strangely aloof to the burning building around it, the sell-off was little wonder.
“You won’t solve the crisis by reducing incentives for the Italian government to act,” ECB governing council member Jens Weidmann told the Financial Times. He also, in a separate speech, called for an end to international pressure on the ECB to act because it could undermine the central bank’s credibility.
While Weidmann, who also heads the German Bundesbank, is from the hard core of ECB bankers who oppose intervention, his comments underline the perhaps impossible position the euro zone finds itself in.
Without wholesale intervention, in the form of massive purchases of government bonds with freshly printed cash from Italy and whichever other state finds itself hard up, the euro project looks very vulnerable to toppling over.
The logic of contagion, this time directed at Spain, is pretty simple. If the ECB won’t act, no force exists to serve as a firebreak, without which financial markets will simply press on, assuming that either a failure or a bail-out with haircuts of one will spread to others.
The risible bending over backward to make Greece appear not to default under the most recent deal is an example, and actually serves to make Weidmann’s point as well.
The moral hazard of an ECB printing German money and giving it to Italy and its creditors, for example, will inevitably bring with it maneuvering by Spain, Ireland and perhaps eventually France for similar terms.
PLANNING FOR FAILURE
German Chancellor Angela Merkel and French President Nicolas Sarkozy first broached the subject of euro exit last month when they labeled a bailout referendum proposed by then Greek Prime Minister Papandreou as a vote on euro membership. That had the intended effect of forcing him into a U-turn before he stepped down, but did let the genie out of the bottle for the rest of the euro zone.
A vote by Merkel’s Christian Democratic Union to allow euro members to leave the euro doesn’t help either. Nor does an unsourced story in Germany’s Der Spiegel contending that German scenario planning envisions a stronger euro area after a Greek exit from the project.
Like it or not, market prices are indicating that an exit by Greece is becoming more likely, and that in itself makes other exits or a wholesale reorganization more likely. This brings us back to the lack of a true central bank in Europe, one that can serve as a lender of last resort for sovereigns. Without that, or a naked policy of huge fiscal transfers from Germany to the south and its creditors, there is little to stop a huge run on sovereign credit, and on the banks that are exposed to sovereign credit.
Those banks are very likely exacerbating things by lightening up their own sovereign exposure, trying to front run what is going to be an absurdly difficult task of raising capital ahead of the supposed mid-2012 targets outlined in the rescue plan.
If there is a benign interpretation of all of this, it is that the ECB, Germany and to an extent France are bargaining hard to extract maximum concessions from southern Europe before they at last backpedal and orchestrate the big money-printing exercise.
Let’s hope that when they reach for that bazooka they find it is still there.
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.