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The Longer the Euro Crisis, the More Dire the Outcome

Tuesday, 26 June 2012 12:54 PM Current | Bio | Archive

Just before this week's EU summit, German Chancellor Angela Merkel has made it clear to her EU counterparts that she dismisses “euro bonds, euro bills and European deposit insurance with joint liability.”

She considers such tactics as “economically wrong and counterproductive and, last but not least, they run against the German constitution.”

Merkel also has dismissed a proposal of Italian Prime Minister Mario Monti to use funds of the “temporary” European Financial Stability Facility (EFSF) or the “permanent” European Stability Mechanism (ESM) to buy bonds and opposed to directly recapitalizing banks.

I don’t think it’s an overstatement to say that nothing has really changed since that other summit in Brussels on Dec. 8, 2011, which was intended to save the euro, but that in fact became a summit that exposed EU’s failure to truly appreciate the gravity of the eurozone’s predicament.

The so-called revamped “fiscal pact” that came out of it was bedeviled from the beginning with the very same flaws that had contributed to the crisis in the first place.

Remember that the EU leaders said "no" to joint debt issuance, "no" to fiscal union, and "no" to a unified Treasury that are all elements that is a pre-requisite for stability in a monetary union devoid of any trace of an optimum currency area.

Germany’s Central Bank (Bundesbank) Chief Jens Weidmann said: “The EMU (European Monetary Union) is in a critical condition.” On the subject of a banking union, he said: “Central banks have their limits,” adding “such a project has far-reaching consequences … the idea that this could be implemented overnight is absurd.”

Weidmann also stated: “In my view it is problematic if the ESM were to have access to financing via the central bank. I see that as the monetary financing of public budgets.”

He said that the ECB’s Securities Markets Program (SMP) bond-buying program is now viewed “much more critically” than at the beginning, and that the ECB’s rate-setting council sees that “the bond buys haven’t addressed the causes of the crisis.”

Investors shouldn’t be surprised to see the EU leaders trying to build upon their recent assertions that euro stability lies with “more Europe” or closer integration, whatever that really may or may not entail. I certainly don’t expect any solution that could get the single-currency club ahead of the curve in addressing eurozone’s debt crises.

To me, it will, once again, be gesture politics at best and given short-shrift by the markets accordingly.

And talking about EU debt crises, it’s interesting to take notice that only less than week after Spain’s Finance Minister Cristobal Montoro told his own Parliament the country didn’t need a “full-blown” bailout, Spain on Monday formally requested a eurozone bailout for its banks, which is of course not a “full-blown” bailout, of as much as 100 billion euros ($125 billion), which is equivalent to 10 percent of Spain’s economy.

In the meantime, Moody's has downgraded the ratings of 28 of Spain’s 33 rated banks, by one to four notches, following a cut to Spain's sovereign rating to just above junk status earlier this month. The agency stated: “The reduced creditworthiness of the Spanish sovereign ... affects the government's ability to support the banks … The banks’ exposures to commercial real estate will likely cause higher losses, which might increase the likelihood that these banks will require external support.”

Cyprus, which takes over the European Union’s rotating presidency on Sunday, has also requested a financial lifeline from the eurozone firewall funds.

The Cypriot government said (no surprise here neither): “The purpose of the required assistance is to contain the risks to the Cypriot economy, notably those arising from the negative spillover effects through its “financial sector,” due to its large exposure to the Greek economy.

One could ask: “Who among the remaining different eurozone states or their banks will be next?”

One of the candidates that comes immediately to my mind is the Italian bank Monte dei Paschi di Siena, which is Italy’s third-largest bank by assets but nevertheless considerably smaller than Italy’s two bigger banks UniCredit and Intesa Sanpaolo, whose trading has been suspended after asking for help.

Last month, Moody’s Investors Service trimmed two notches off Monte dei Paschi’s rating to move the bank to one level above junk.

So far, the EU debt crisis only shows signs of getting confusingly worse instead of improving and being stuck on some kind of mud on a dead-end road. It should not come as a surprise to investors we actually see what appears a growing shortage of eligible (AAA) collateral, which in turn is causing financial liquidity to contract. Unfortunately, I can’t see what could change this bad situation for the better in the short term.

In contradiction to what most EU politicians want us to believe, in my opinion, “euro-sclerosis,” which was a term coined in the 1970s and the early 1980s to describe, in a political context, a period with a perceived stagnation of European integration is lurking below the EU surface of apparent denial to resolve in a serious and sustainable way the EU debt crisis and its contagion.

Please don’t take me wrong, and I certainly don’t wish that to happen, but if that were to happen, investors should be prepared for a full-blown negative fall-out worldwide. (The term “euro-sclerosis” was originally coined by German economist Herbert Giersch to describe how overregulation and a generous welfare state will undermine efficiency and job creation.)

There is unprecedented tension in the eurozone between the economic need for further EU integration and the political reality that makes further integration harder than ever. There are plenty of uncertainties and I’m convinced these uncertainties are not close to being resolved. The crisis is far from over and we have yet to see it to reach its climax. How and when that will end is anybody’s guess, but I’m afraid it won’t be nice.

Speaking of EU contagion, worldwide we see developed as well as emerging economies slowing down.

One thing is for sure to me: the longer the eurozone debt crisis drags on, the greater we are at risk for a bad ending. Long-term term investors could do well to keep that in mind.

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Tuesday, 26 June 2012 12:54 PM
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