The contradictions of the Eurobailout mechanism were bound to be resolved at some point, smoke and mirror and insufficient firepower relative to the magnitude of the problem will only take you so far. The eurozone rescue operation, although it looked like it was aimed at so called Club Med, aka PIGS sovereigns (Portugal, Ireland, Greece, and Spain) was at least as much about preventing the banks that are exposed to their debt from taking too much pain, and those banks are mainly French and German.
The current vogue, austerity measures, sounds straightforward until the ugly reality kicks in, that all it does is put countries into a deflationary spiral, making debt loads ever worse. As Satyajit Das pointed out a month ago:
The “cure” may be worse than the disease. After implementing austerity measures, Ireland’s nominal gross domestic product (”GDP”) has fallen by nearly 20%. The budget deficit as a percentage of GDP has doubled to 14% from 7% Government debt as a percentage of GDP has increased to 64% from 44% at the start of the crisis. It is forecast to go to over 100% having been around 25% during the boom years. The cost of bailing out Ireland’s banking system has risen and may reach 20-30% of its GDP. Ireland’s credit rating has fallen.
In late September 2010, Ireland announced that in the second quarter the economy contracted by 1.2%, against expectations for 0.4% growth raising renewed concerns about European sovereign risk. Similar scenarios are playing out in Spain and Portugal.
The trigger for action by Germany is that the rescue mechanism put in place last May was temporary and expires in 2013, and any ongoing arrangement requires changes in EU treaties. And Germany, as the strongest nation in the eurozone, insists on exerting considerable influence on the design of its successor. While there was not immediate pressure to develop a permanent mechanism at this juncture, Germany appears to have caught its eurozone partners off guard, to its advantage.
Ambrose Evans-Pritchard of the Telegraph is not terribly popular among European readers of this blog, but his analysis of the implications of the German proposal (of which key elements have been agreed, details to be hashed out over the next several months) is insightful. He points out that the austerity measures are likely to backfire, that as currently structured, they demand too much of local populations and not enough in the way of corresponding adjustments (meaning writeoffs or debt restructuring) by the banks. While the Merkel initiative addresses that imbalance by insisting that bondholders, meaning banks, take losses if things get rocky, there is never a good time to implement a change, since investors will reprice assets based on the weaker guarantees going forward. The issue is that spreads on Ireland and Greek debt have already widened in the last month; this move will push them out further, making any efforts to access the markets more costly. And there is plenty of debt issuance planned.
From the Telegraph (hat tip Richard Smith):
Bondholders will discover burden-sharing. Debt relief will be enforced, either by interest holidays or haircuts on the value of the bonds. Investors will pay the price for failing to grasp the mechanical and obvious point that currency unions do not eliminate risk: they switch it from exchange risk to default risk…
“We must keep in mind the feelings of our people, who have a justified desire to see that private investors are also on the hook, and not just taxpayers,” said German Chancellor Angela Merkel.
Or in the words of Bundesbank chief Axel Weber: “Next time there is a problem, (bondholders) should be part of the solution rather than part of the problem. So far the only ones who have paid for the solution are the taxpayers.”
http://www.nakedcapitalism.com/2010/11/germany-draws-line-in-the-sand-on-eurozone-bailouts-insists-bondholders-take-pain.html
Printer-friendly format
Email this thread to a friend
Bookmark this thread
(1000+ posts)
Send PM |
Profile |
Ignore
