So, now we know what the latest euro-crisis summit has to offer. The fifth comprehensive effort to stabilize to eurozone in nineteen months, this latest Brussels gab-fest produced a slew of headlines and initiatives. But what did it really achieve? The single currency remains just as incoherent as it was last weekend, just as vulnerable to systemic collapse. The region’s banks and governments are still very highly indebted. Eurozone leaders are deluded if they think some diplomatic sticking plaster, and a lot of bluster, can hold together an inherently unstable structure.
What’s more, to use a combination of borrowed and printed money to bail-out cash-strapped governments, which are insolvent largely because they, in turn, are standing behind insolvent banks, is to treat the symptoms of the crisis, not the cause. This historic policy error – tackling the results of the problem rather than the problem itself – has characterized the West’s response to this sub-prime fiasco from the very beginning, not just in the eurozone but the UK and US too. Europe’s predicament is so much worse, though, given the restrictions imposed by the single-currency straitjacket.
It was David Cameron’s “veto” and the UK’s new status as “Europe’s outcast” that gained most attention, at least in the UK press. Of far more importance though, in Britain, Europe and the world, is whether these latest Brussels initiatives can prevent a “euroquake” – a disorderly, market-driven break-up of monetary union. Were that to happen, the economic shockwaves would be felt across the globe.
Prior to the summit, the European Central Bank slashed its 2012 eurozone GDP growth forecast from 1.3pc to 0.3pc. The refinancing rate was cut by 25 basis points, to 1pc. The ECB also unleased a battery of “non-standard” measures to support Europe’s ailing banks.
Refinancing operations were extended to three years and collateral eligibility expanded still further, making it easier for banks to borrow from the eurozone’s central bank. Reserve ratios were also lowered, the ECB throwing regulatory caution to the wind, in a bid to get eurozone banks lending.
Then there were the measures adopted at the summit itself. Despite Britain’s veto of a EU-wide “fiscal compact”, eurozone members will press on with budgetary integration, but outside the EU’s legal framework. A new “stability union” will see member states adopting a “golden rule” to run structural deficits below 0.5pc of GDP. Countries breaching a 3pc of GDP deficit limit will be fined, unless qualified majority voting decides otherwise (that is, unless various governments agree to let one another off, which of course they will).
These tired measures, pave the way for “full fiscal union”, we’re told. Yet they’re almost identical to the failed “stability and growth pact” that was around when the euro launched, and which both France and Germany breached very shortly thereafter.
In the end, such rules will always be broken because, when it comes to something as fundamental as tax and spend, eurozone governments will always do what their national electorates want, rather than following Brussels. We shouldn’t be surprised by this. Western Europe is a collection of sovereign democracies. This is how it should be.
Other announcements included the “rapid deployment” of the €440bn European Financial Stability Facility, to prop-up distressed governments such as those in Greece, Italy and Spain, preventing “contagion” from spreading across the eurozone. Yet no-one quite knows where the €440bn will come from. The eurocrats acknowledge this by referring to the EFSF as “leveraged”. But who will lend money to an entity that has no obvious income stream?
The new European Stability Mechanism apparently has €500bn to spend, so bolstering the “firewall”. Yet another acronym we must add to the bail-out lexicon, the ESM will now come “on stream” by July 2012, earlier than previously expected. Again, though, we don’t know whose money it will be dishing-out. But we do know that Finland and Holland, among others, are furious France has insisted that decisions to wield whatever money the ESM eventually does have need not be unanimous. The Finnish Parliament has already judged this proposal as “unconstitutional”.
Something else we know is that the eurozone has agreed to “lend” €200bn to the International Monetary Fund via member states’ central banks, which the IMF can then lend back to eurozone member states. This amounts to another circumvention of the law. Eurozone government’s can’t fund bail-outs directly, because their populations would be outraged and national Parliaments would refuse. But by channeling money through central banks, and then “round-tripping” via the IMF, bail-out funds can be delivered while ignoring such democratic niceties. This is the kind of deeply immoral behavior the eurocrats present as a “break-through”.
The eurozone faces an imminent, acute funding problem. Member states need to repay over $1,100bn of debt in 2012, the bulk of it due in the first six months. On top of that, European banks, heavily dependent on state largesse, have around $665 billion of debt coming due by June next year.
Germany still insists the ECB won’t be allowed to unleash full-on QE, or buy bonds much beyond the $210bn it has already sneakily spent. Many believe Angela Merkel will ultimately relent. I still don’t think she will, not least because her Parliament and electorate won’t let her. That’s why the eurozone’s big test still lies ahead, even if that test may have been shelved until early next year, when the big re-financing needs come due.
This Brussels summit was an unseemly combination of law-bending and posturing. The coup de grace, for me, was the quiet agreement to drop any requirement for private sector holders of dodgy eurozone sovereign debts to incur losses. So much for moral hazard.
The fundamental problem remains that Europe’s banks remain locked-out of traditional funding markets, leaving them reliant on the ECB – which, in turn, is now increasingly reliant on covertly printed money and whatever the Chinese and others will ultimately chip-in. Faced with a funding freeze, banks are shrinking their balance sheets and strangling growth by refusing to lend, a problem the ECB’s “special measures” will do nothing to address.
The use of the ECB’s emergency lending facility rose last Wednesday to €9.4bn, the highest daily total since early March, pointing to deep-seated banking sector distress. Such distress relates, above all, to a lack of trust. Eurozone banks can’t raise cash, and won’t even lend to each other, due to crippling fears of counter-party risk, given that many continue to hide massive liabilities in so-called “special purpose vehicles”. Lawmakers, after all, still lack the courage to force them to fully disclose their losses.
This lack of disclosure is the nub of the sub-prime problem. Nobody wants to hear it, but it’s true. Last week’s “stress tests” suggested Europe’s banks have a deficit of €115bn, up from €106bn in October. But these government-run tests lack credibility. The first round cleared some big Irish banks, which then went bust. A subsequent round gave Belgium’s Dexia a clean bill of health, just weeks before it imploded. And now the European authorities want the markets to believe this latest exercise in high-stakes financial spin.
No-one knows who is solvent. The drip-drip of stress test information causes more problems than it solves. So stand-behind retail depositors, impose “full disclosure” and let the cards fall, forcing our bombed-out banks to consolidate. This really is the only solution – in the US, the UK and the eurozone. But the eurozone’s failure to grasp it will be far more explosive, given the pressures being created by this absurd monetary experiment.