Gideon Rachman, Financial Times:
...while Europeans no longer fear foreign armies, they are starting to fear foreign bondholders. Europe's existence as a "lifestyle superpower' has depended on an ample supply of credit...
Marc Ostwald, Monument Securities:
...this is just another example of a short-term, leveraged solution, that merely adds to the burden of future problems...
Roughly one week ago Jean-Claude Trichet, aka "Mr. Euro," was telling the world there was no way the ECB would go nuclear. Then, over the weekend, they went nuclear.
Rather than dropping an atomic bomb, however, Europe dropped a money bomb on the markets – a rescue package worth some $962 billion, give or take. The package included authority for the ECB to wade into the markets and directly purchase debt.
It was as if the hapless trio (Merkel, Sarkozy and Trichet) had read Friday's Taipan Daily, "Why the Euro Must Die (To Save the Eurozone)," and decided to take the advice:
There is perhaps just one thing left to do: Destroy the euro. Jean-Claude Trichet, the head of the ECB (European Central Bank), should swallow hard... admit his failure... and print like a madman, devaluing the currency in order to "monetize" the vulnerable eurozone countries' debts.
Amusingly, the euro opened sharply higher in the Monday post-rescue afterglow. But then it proceeded to drop like a rock the entire day. The euro's higher opening was more or less short covering, as traders with overly tight stops found themselves squeezed by the banks. In currency trading terms, the "shock and awe" of Europe's incredible rescue was good for less than half a percent on the day.
"This package serves to protect and strengthen our common currency," Chancellor Merkel told reporters in Berlin. She might as well have tried selling them the Brooklyn Bridge. The package does no such thing.
Frankenstein Death Throes
This whole affair is a giant tragicomedy – like watching a global financial version of King Lear. ("Tragic" because so many innocent people are being caught up in this mess. "Comic" because the blunders are so predictable... and so ridiculous.)
Instead of witnessing the death of a king, however, we are witnessing the early death throes of Frankenstein... or rather, a Frankenstein currency. The euro was always a lousy idea – a hodgepodge of disparate cultures and loyalties and economic climates, stitched together in a mad Brussels laboratory.
The euro came into existence as a sort of geopolitical salve. France and others were afraid of German strength – shades of World War II and all that – and wanted a means of wrapping Germany in loving economic tendrils via "ever closer union," as a way to dampen German power and mitigate the possibility of future conflict. But marriages of geopolitical convenience do not always make economic sense... and this one never did.
A Play for Time
Impressive as it sounds, the trillion-dollar rescue package – which still has major logistical kinks to be worked out – essentially buys time and nothing more. The real problems of the eurozone are left woefully unaddressed. If anything, in fact, those problems have been made worse by this desperate action. Consider the following:
- Europe is effectively borrowing huge sums from itself.
- Spain and Portugal now have far less incentive to "belt tighten" than before.
- The issues of high unemployment (Spain +20%) and slow growth still loom.
- Greece, aka "patient zero," is still at long-run risk of default.
- The ECB's credibility has been torn to shreds.
Can we believe anything the European Central Bank has to say? Last week they said debt monetization (buying bonds) was not even under discussion. Then they did exactly that a few days later.
Bloomberg columnist Matthew Lynn laments:
If the rules of the euro can be rewritten on a Sunday night in Brussels once, they can be rewritten next time there is a crisis. Investors will remember that. And they won't believe what they are told about how the euro operates from now on.
The eurozone has zero political credibility. Europe's leaders have been flailing for months. And now the ECB has no inflation-fighting credibility either... and there is no genuine solution in sight. If anything there are more street protests and more political turmoil in sight, as the man in the European street elects to stand up and revolt. The whole thing is coming apart at the seams.
The Fruits of Unnatural Union
The eurozone debt crisis was a long time coming. Greece and the other PIGS did not become profligate in a day. They ran up credit card bills at artificially low interest rates for many years.
Deep thinker Michael Pettis further argues that the existence of the euro itself created serious payment imbalances. Forcing countries like Germany, Spain and Greece into the same economic straitjacket meant that massive German surpluses – Deutschland is an export powerhouse on par with China – were practically guaranteed to stoke burgeoning deficits in economically weaker, less efficient eurozone countries.
This is the kind of thing that happens when you force an unnatural union. Gross imbalances build up via ignorance and neglect. Some people, and some countries, were just never meant to be joined at the hip.
The Mother of All Moral Hazards
But past mistakes don't matter now – what's done is done. The new trouble is this: By going "all in," pushing a huge stack of chips into the middle of the table, Europe has stoked the mother of all moral hazards. And they have left themselves no more outs.
Moral hazard is defined by the Princeton dictionary as:
The lack of any incentive to guard against a risk when you are protected against it (as by insurance).
Moral hazard is especially great when that insurance is provided, free of cost, by some overly generous third party.
Now that Europe has made clear its intention to bail out weaker members at any cost, the pressure for economic reform has lessened. The "risk" of future troubles has been sloughed off – greatly increasing the odds that trouble will come again.
After all, politicians in Spain, Portugal and Italy had to be watching the firebomb riots in the streets of Athens with keen interest... wondering in the back of their minds, "Could that be us (if we push austerity too far)?" Thanks to fierce Greek resistance, desire to implement truly painful budget cuts was already at low tide for the others. Now that weak resolve has ebbed even lower, thanks to a trillion-dollar get-out-of-jail free card with no conditions attached.
As Gideon Rachman writes in the Financial Times:
Many [Europeans] have come to regard early retirement, free public healthcare and generous unemployment benefits, as fundamental rights. They stopped asking, a long time ago, how these things were paid for. It is this sense of entitlement that makes reform so very difficult...
And as former IMF chief economist Simon Johnson adds:
This is a whole new level of global moral hazard – the result of an alliance of convenience between troubled governments in the south of Europe and the north European banks (and implicitly, north American banks) who enabled their debt habit.
Speaking of banks ... the unrepentant idiot-child banks, who seemingly show up at the heart of every financial crisis – and are of course loaded to the gills with dodgy eurozone debt – can rest easier for now too. The state has rescued them yet again, taxpayers be damned. (Of course, to a large degree, saving the banks is what this trillion-dollar bailout is all about. Surprise!)
But I'm not the only one who talks about surprises in the global markets. Sign up and read my fellow editor Adam Lass' latest on financial market trends and investment commentary.
Massive Political Risk
The chief economist of Commerzbank opines:
The debt crisis will change the nature of European monetary union. The eurozone has moved away from a monetary union and toward a transfer union.
The question of just who will pay the eurozone bailout tab is a very tricky one. There is huge political risk here, as voters in the northern eurozone countries grow furious at the idea of transferring funds to southern ones on a truly cartoonish scale.
A serious problem with this "shock and awe" directive is thus how directly at odds the politicians have become with the people. The plan to transfer huge fiscal payments from one area of the eurozone to another comes from elitists in Brussels, not from the popular will. And many European citizens will see this exercise for what it is: A last-ditch rescue measure for a problem that never should have festered in the first place, and another excuse to throw good money after bad.
Adding insult to injury, the "rich" eurozone countries have long-brewing problems of their own. Even mighty Germany has bills to pay and fiscal issues to work out. The reluctant rescuers are not so impressively far removed from those in need of rescue... another reason why this whole charade is the rough equivalent of rearranging deck chairs on the Titanic.
Citigroup (NYSE:C), Enron and 1992
The massive political risk in part explains why the trillion-dollar bailout has been engineered in just about the shadiest way possible. As The New York Times explains:
The idea was for a new mechanism euphemistically called "a special purpose vehicle" – essentially eurobonds created by intergovernmental agreement among euro zone countries. That vehicle, supposedly to last only three years, would raise up to 440 billion euros on the markets with loans and loan guarantees, depending on the need.
Do you know what a "special purpose vehicle" (or "SPV") is? It's a means of concealing garbage accounting – a way to take a huge slug of debt "off balance sheet" and pretend it isn't there. SPVs, in other words, are the province of sleazeball accountants. They are deceptive by design. Impenetrable opacity is not a bug, but a feature.
And that's why the very term "special purpose vehicle" conjures up the likes of Enron and Citigroup – two heavy-duty SPV users who blew up spectacularly when their misdeeds came to light.
The trillion-dollar bailout terms are being funneled through an SPV so that Europe can play games... hiding true costs, masking the flow of payouts, and so on. It's a ruse designed to protect politicians from their mad-as-hell constituents. And the bailout itself is also something of a fiction in that we don't even know how the real cash will materialize. Again from the NYT:
Indeed, for all the excitement about the scale of the effort, it is important to remember that the core fund does not now exist...
In a last bit of irony, the powers that be have elected to dub their new ruse the "European Stabilization Mechanism." This "ESM" has delicious resemblance to the "European Exchange Rate Mechanism," or "ERM," which facilitated a huge breakdown in the British pound (and a billion-dollar payday for George Soros) back in 1992. It appears those who don't learn from history are doomed to repeat it...
The Only Hope ... A (Much) Cheaper Euro
Look. You can't borrow your way out of debt. More loans won't do it – you have to save and grow your way out. Saving and growing require an upswing in productivity.
Thus the struggling PIGS – Portugal, Italy, Spain, etc. – do not just have a debt problem, they have an economic growth problem. They have to get more productive. At the end of the day, this means exporting more... which means taking advantage of a cheaper euro.
From a structural standpoint, the euro should be trading much, much lower. From a pure growth potential standpoint, the economic fundamentals of the eurozone are terrible compared to the United States. A cheaper euro would both lessen the debt burden for struggling eurozone countries and increase the odds of growth via more competitive exports.
This is a big reason why we will see a much lower euro from here... and why the powers that be might even be secretly praying for that to happen. Further decline is just a matter of time. It only makes sense, given the trashing of credibility and the temptation to devalue.
There are further reasons why Europe might be better off with no euro – why scrapping the whole sorry project might truly be the best thing – but that's a discussion for another day.
Disclosure: No positions