James Saft

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).

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

The plan to rescue the euro zone faces only three hurdles; democracy, reality, and supply and demand.If they can overcome those, it is going to work perfectly, and, amazingly, they just might.

Democracy reared its rather large head when the Greek government decided suddenly that it wanted a sign-off from its voters and moved to put the plan to a plebiscite.

While it is hard to argue with the idea of a people getting a chance to vote directly on a plan that will mean tough times for the better part of the next decade, the move jeopardizes not only the confidence on which the entire rescue relies but also the next infusion of much-needed cash Greece is slated to get in November.

If the Greeks vote against the plan it means a full-fledged, badly controlled sovereign default, with all that implies for euro zone banks. Is that something the Greeks will vote for, even if it means ejection from the euro zone? Just the specter of the vote makes it far harder for euro zone officials to put the rest of their plan into effect, a number of whose planks are already looking shaky.

Democracy, or whatever alternative term you would prefer to use, is also doing the rescue no favors in Italy, where Prime Minister Silvio Berlusconi is under pressure to step aside for a government of national unity. There is also precious little faith that Italy will produce credible fiscal and structural reforms. All of this is reflected most starkly in the reality of the bond market. Italian 10-year bond yields now stand at about 6.16 percent, a level that is unsustainable, considerably higher than before the grand plan was announced, and a threat in and of itself to the rest of the plan’s moving pieces.

Remember, Italy is not only the third-largest economy in the euro zone, and probably too big to bail out, but the third-largest government bond market in the world. A plan that can’t bring Italian borrowing costs back down is one which will fail.

If anyone ever wondered where the bond market vigilantes have gone, we have our answer: they’ve moved to Europe and are providing reality therapy to governments.

Again, sometimes that kind of therapy works, and perhaps Italy will come across with the goods. The problem is time and moving parts — too little of one, too many of the other.

EFSF, RATINGS AND THE MARKET

The European Financial Stability Facility, the fund which is supposed to borrow funds under government guarantees to pay for the bailout, chose to delay a planned bond offering on Wednesday, its arrangers citing market volatility. There is also the little issue that euro zone officials have failed thus far to explain exactly how the vehicle is supposed to work.

The EFSF is supposed to create friendly market conditions by being big enough and bad enough to fund weaker countries regardless of their stand-alone fundamentals. It is not supposed to be subject to the market and the fact that it is, so soon, is a bad sign.

And the larger the number of countries which might be borrowing from the EFSF rather than contributing to it, the less solid its AAA status seems, as well as the AAA status of its backing nations.

France is the case in point — as the number of strong countries dwindles, its own AAA status looks less reliable. Bond investors drove the premium France must pay to borrow for 10 years compared to Germany to a euro-era record on Wednesday to 129 basis points.

The final issue where supply and demand are working against the euro zone plan is in banking, where banks have been given a deadline of next June to recapitalize, either in the market or with state support.

That means that many banks are going to be trying to either raise capital or sell assets at the same time, driving up the price of the first and down those of the second. It also implies a rather large credit crunch in Europe, one that probably has already begun on the fringes.

That means Europe‘s recession will get a kick downhill.

So, to overcome democracy, reality, and supply and demand Europe is going to need a force that is immune to some degree to all three. Such a force exists in most other large developed countries with independent currencies — the central bank.

The ECB can’t and won’t play a similar role, and until it decides it should and a way is smoothed for that to happen, the odds are against the plan.

(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 and find more columns here.)