The Eurozone's Never-Ending Crisis

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Includes: BWX, BWZ, ERO, TLO, UUP
by: Acting Man


It Just Won't Go Away….

It is fascinating, and testament to the powers of the remnants of the free market that exist underneath the thicket of regulations and taxes that smother the entrepreneurial spirit everywhere in the industrialized West these days, that day-to day life seems to be mostly continuing along its well-worn paths without a hiccup, even while the drama of the fiat money system's and welfare state's biggest crisis yet is playing out in the background.

Naturally, the above cannot be said of the nations stricken the most by the crisis. In Greece, the battle between the political leadership, the various vested interests it has allowed to flourish over decades of statist corruption and the people in the street is continually paralyzing public life. We mentioned yesterday that Greece was unable to meet its fiscal targets even in the just expired month of June. This should be no surprise – inter alia, the month was marked by yet another 48 hour long general strike, massive demonstrations and a tightrope drama over whether the government would be able to continue to receive any financing at all. All of this was bound to hurt economic productivity, and it did.

And yet, the shelves of our supermarkets continue to be brimming with goods, when switching on the TV, we are inundated with advertisements offering the latest great deals in mobile communication, indeed, we have an ever larger array of goods and services to choose from. In short, wherever one looks, the achievements of the free market continue to be in evidence. However, these achievements should not be taken for granted. How easily the capital consumption induced by the booms engendered by the four decades old experiment in unfettered fiat money can bring an economy to its knees is currently amply demonstrated in the euro area's periphery.

Every time the eurocracy comes up with a new ad hoc fix to delay the inevitable – namely the default of the most indebted governments on the periphery – the financial markets are celebrating as though they had just witnessed a unique luxury miracle of the sort provided by Jesus in Canaa, where he reportedly turned water into wine or the associated miracle of multiplying a few loaves of bread and two fishes with a wave of his hand in order to feed the multitudes. However, it now appears that the time spans between the celebrations in stock and commodities markets and the subsequent sobering up when it becomes clear that nothing has really changed are growing ever shorter these days.

A Portuguese Reminder

As our readers are probably aware, one of the features of the latest iteration of the crisis was that it brought back the very contagion effect that had previously been absent for a while. Olli Rehn, the EU's commissioner for economics and finance, even boasted sotto voce at one point that the eurocracy had managed to 'contain' the crisis to the three small peripheral economies that are currently vegetating under the strictures imposed by the EU's bailout regime. It seems highly likely that he will come to regret this boast.

Just as the 'Greece is saved again' party was beginning to raise the frequency and generosity of bullish pronouncements issued by Wall Street's community of shills, Moody's reminded everyone that the credit rating agencies nowadays have a acquired a new role, namely that of the spoilers of greed-induced dreams of riches.

As Reuters reports, Moody's just decided that it would be a good time to downgrade Portugal's government debt by several notches into 'junk' territory.

“Caution over the euro zone debt crisis resurfaced after Moody's became the first ratings agency to cut the credit rating for Portugal by four notches to non-investment grade, warning the country may need a second round of rescue funds before it can return to capital markets.”

Not only that, but as the same report informs us, in spite of the assurances by Wen Jiabao during his recent European trip that China's central planners had 'vanquished inflation' – which brought forth fantasies about the imminence of a fresh round of monetary pumping in China – the PBoC still appears to deem inflation quite unvanquished at this point.

“China's central bank increased interest rates for the third time this year on Wednesday, making clear that taming inflation is a top priority as its economy gently slows.”

Happily, China's economy is 'slowing gently,' a choice of words that mirrors the currently immensely popular 'China is coming in for a soft landing' meme. The reason why this meme is so popular is that Western mainstream economists and players in the financial markets as a rule can simply not imagine any negative outcomes. Obviously, a decline in economic growth is not a good thing, hence the euphemistic 'soft landing' semantic packaging of the event. There are in fact a great many things to worry about when looking at China's economy, all of which suggest that the widely expected soft landing could well turn into a crash landing. The idea that 'inflation has peaked or will soon peak in China' is equally popular – we've been hearing about it for many months. We are going to discuss China in more detail in these pages soon, but for now let us return to Portugal's latest woes.

In Europe, frustration over the US based credit rating agencies is understandably growing. Since when, so everybody is wondering, are these agencies so eager to issue downgrades? People remember that in the mortgage finance arena, the rating agencies in many cases waited so long with issuing downgrades that they had to go from 'AAA' to 'D' ratings in one fell swoop. By contrast, they have been all over Europe for quite some time now. As we have mentioned, we believe the rating agencies are eager to repair their damaged reputation. Alas, as Bill Buckley, who writes Australia's Privateer newsletter frequently points out, it is also an excellent way of deflecting attention from the other elephant in the room – the growing fiscal train wreck across the great pond in the good old US.

As the FT reports:

“Portugal has hit back at Moody’s for downgrading the country’s sovereign debt to junk status, criticizing the US rating agency for failing to take into account new austerity measures and a “broad political consensus” in favour of tough fiscal discipline.

The four-notch downgrade to Ba2 has dealt a blow to Portugal’s efforts to distance itself from Greece and is expected to increase the yield the country has to pay at an auction of up to €1bn ($1.4bn) of three-month treasury bills on Wednesday. Portugal’s PSI equity index quickly fell 2.6 per cent and the country’s credit default swaps have hit a record of 850 basis points, up 80bp for the day. Spreads between Spanish and Italian sovereigns and Bunds are also widening, indicating contagion fears. Vítor Gaspar, finance minister, said the ratings cut to below investment grade failed to reflect the unequivocal support of the main government and opposition parties for the country’s €78bn financial rescue programme.

The Portuguese media gave wide coverage on Wednesday to the negative impact the downgrade was expected to have on the country’s standing in international debt markets. Pedro Santos Guerreiro, editor of the Jornal de Negócios business daily, said the ratings cut threatened to become a self-fulfilling prophecy, undermining the investor confidence Portugal needed to resolve its debt crisis.”

(our emphasis)

Mr. Santos Guerreira has a point: the barrage of credit downgrades does bring a 'self-fulfilling prophecy' effect with it. Greece's foreign minister lambasted the decision along similar lines:

“Stavros Lambridinis told a conference in Berlin that the decision by the ratings agency late on Tuesday to downgrade Portuguese debt was not based on any failure to implement economic reforms.

Lambridinis said that this had "the wonderful madness of self-fulfilling prophecy" by aggravating Portugal's fiscal straits, and exacerbating an already difficult situation.”

On the other hand there can be no doubt that a great amount of unsound credit has been amassed. The rating agencies are in a difficult situation – no doubt they are aware that their rating actions worsen the situation for the debtors concerned. On the other hand, they must make a judgment reflecting economic and political reality. One could well argue that the faster markets are discounting this reality, the better. Slowly but surely a feeling of despair is setting in among the eurocrats, as the Guardian reports:


“There is a growing sense of despair in Brussels. Unlike previous attacks on the euro project, the latest downgrade of Portugal's debt by the ratings agency Moody's feels like the beginning of the end.

Those economists and fund managers who argued that a second bailout for Greece with private sector involvement would mean something similar for Portugal and most likely Ireland are hitting their target.

Like a 19th century battalion holding the line against oncoming hoards with depleted firepower and an officer class at war with itself, the euro's supporters are in a desperate situation.

Since last year's Greek debacle, European leaders have sought to provide lifelines to the worst hit countries by replacing the private debt markets with the European Central Bank. The ECB now holds almost £100bn of Greek debt. Portugal was in much the same position, but hoped to muddle through its crisis with just one bailout from Brussels. Moody's says it is likely to join Greece in a second bailout because, like with Greece, private lenders are going to stay away for longer than expected.

Investors ask why they should buy the bonds issued by a country that will be forced to change the terms for the worse mid way through the life of the loan. That is what Brussels is contemplating for Greece. Moody's naturally assumes the same will be imposed on Lisbon.

Just as we found in the worst period of the banking crisis, attempts by politicians to save money and preserve asset values only make the situation worse.”

(our emphasis)

This is precisely the heart of the problem: propping up unsound investments and unsound credit does nothing to resolve the underlying fundamental problems. On the contrary, it makes these problems worse. The eurocrats always insist that the bailout operations are designed to 'save the euro,' but it is never made clear why exactly a default and debt restructuring of Greece and/or Portugal would 'destroy' the euro. Such restructurings would lead to a belated recognition of the losses that are already evident in the market prices of debt securities issued by these countries, but this would not mean that the euro as such would be instantly doomed. Imagine if e.g. Arkansas, or New Jersey, were to go bankrupt. Would anyone expect this to spell the end of the dollar?

However, in one respect the eurocrats are correct when they make such pronouncements: the crisis is definitely a crisis of the modern-day monetary system. It was after all the artificial credit induced boom, set into motion due to central bank interest rates being kept too low for too long, that has brought about the great crisis of the banking system in 2008 and the current echo crisis in sovereign debt in the euro-area.

Even if it is true, as some contend, that the actions of the rating agencies in Europe serve a secondary goal of distracting everyone from the public debt problem in the US while at the same time torpedoing the currently sole viable contender to ending the dollar's hegemony as the world's main 'reserve currency,' the crisis is ultimately unlikely to simply halt in the euro area. The imbalances that have led to the crisis are in evidence all over the world. After all, the whole world is on a 'fiat money standard,' and there is objectively speaking very little difference between the unproductive debtbergs of the euro area sovereigns and the corresponding debtbergs elsewhere in the world. If it is a distraction, it is however still working for now.

As Bloomberg reports:

Treasuries rose as Moody’s Investors Service lowered Portuguese debt to junk status, spurring demand for the safest assets. Ten-year notes erased an earlier decline, pushing the yield to the lowest level since June 30. German bunds rose, stocks fell and debt from Italy and Spain tumbled after Moody’s cut Portugal’s long-term ranking late yesterday to Ba2, two levels below investment grade, citing “the growing risk” that Portugal will require an additional international bailout.

“We’re certainly in a risk-off environment today, with equities lower and Treasuries higher,” Orlando Green, a fixed- income strategist at Credit Agricole Corporate & Investment Bank in London. “The news on Portugal adds to the risk-off sentiment and underpins Treasuries and bunds.”

(our emphasis)

Is anyone else struck by the stupidity of this vapid 'risk on/risk off' dance? It is of course deeply ironic that the debt paper issued by the US and Germany is still regarded as the 'safe haven' of choice whenever renewed trouble with the debt of other sovereigns erupts. Anyone who looks a bit more closely at the fiscal affairs of the governments of these two countries, including their so-called 'unfunded liabilities,' can probably only shake his or her head in amazement. An alien visitor from Rigel-2 would either think we're playing an elaborate video game, or more likely declare us all certifiably insane.

The Schachtschneider Echo

In the translation of the interview of Mr. Karl Albrecht Schachtschneider, the leader of one prominent group of complainants to the German constitutional court over the euro area bailouts, that we brought you yesterday, Schachtschneider remarked that the bailouts were inter alia legally dubious due to the infringement on the sovereignty of the recipients of bailout funds they entail. This was promptly echoed yesterday in remarks made by the leader of the euro-group, Luxembourg's prime minister Claude Juncker (the man who at one point declared lying a legitimate tactic for eurocrats in order to 'calm financial markets'). As the Irish Independent reports:

“GREECE received a stark warning yesterday about the cost of the latest bailout in comments which were likely to send a chill down the spines of citizens in other countries that may need further bailouts.

"The sovereignty of Greece will be massively limited," Eurogroup chairman Jean-Claude Juncker told Germany's 'Focus' magazine in the interview released yesterday. "One cannot be allowed to insult the Greeks. But one has to help them. They have said they are ready to accept expertise from the eurozone," the Luxembourg prime minister added.

Like the Irish, the Greeks are acutely sensitive to any infringement of their sovereignty and any suggestion that foreign "commissars" might become involved in running the country is an incendiary political issue and could trigger more street protests. The comments came hours after eurozone finance ministers, including Michael Noonan, approved a €12bn instalment of Greece's bailout and signalled in the teleconference that Athens must expect significant losses of sovereignty and jobs.”

Juncker seems particularly strongly afflicted with foot-in-mouth disease these days. Such remarks, while certainly reflective of reality, are as undiplomatic as it gets and unlikely to help the eurocracy's cause. The expected reaction from Greece followed promptly:

“Public sector union ADEDY, which has resisted the Socialist government’s austerity measures holding a series of strikes, on Monday slammed Juncker’s comments.

”Mr Juncker interferes in the internal affairs of a country, provokes European rules and is an embarrassment for the country whose government tolerates him,” ADEDY chief Spyros Papaspyros said. The issue of outside interference is a sensitive one for Greeks. Speaking in Parliament last week, Finance Minister Evangelos Venizelos told deputies said that backing the austerity plans was necessary so that Greece “does not become converted, step by step, into a protectorate.”

As Mr. Schachtschneider so perceptively noted, the bailouts are a major step toward the elimination of the sovereignty of euro area member nations and consequently the creation of a European super-State.

The German constitutional court meanwhile rebuffed the economic arguments made by Germany's finance minister at the beginning of the hearings yesterday:

“Germany’s finance minister defended the rescue packages for Greece and other eurozone countries at a supreme court hearing Tuesday, as opponents argued that the bailouts violated both German and European law.

Wolfgang Schaeuble told the Federal Constitutional Court that «the stability of the euro is of paramount significance.» He pointed to the risk of financial instability across Europe and beyond at the time when the government signed on to the initial Greek rescue of May 2010 and also the wider eurozone fund created shortly afterward. Those plans foresee Germany — Europe’s biggest economy — guaranteeing loans up to 22.4 billion euros($32.5 billion) for Greece and 147.6 billion euros for other countries.

Plaintiffs include Peter Gauweiler, a member of Chancellor Angela Merkel’s conservative bloc, who challenged previous European integration measures, and a group of professors.

Chief justice Andreas Vosskuhle said the court didn’t want to hear a debate on the measures’ economic merits, and that the right economic strategy was a matter for politicians and not judges. But, he said, his court «has to consider the limits that the constitution sets for politicians.» Karl Albrecht Schachtschneider, speaking for the professors, insisted that "what is economically wrong can’t be legally right." He argued that the rescue measures violated a no-bailout provision in the European Union’s Lisbon treaty without sufficient justification.

He also contended that they violated German constitutional clauses protecting property and democracy – the latter by restricting the German parliament’s control over its own budget. "A union of liability and debt favoring other states has been created," he said.

Gauweiler’s representative, Dietrich Murswiek, pointed to current efforts to set up a second Greek rescue package, arguing that loans would sink into a "bottomless pit." "It’s like trying to repair water damage by blowing up the house," he said. In addition, "the rescue fund serves in reality to take risks away from certain big banks," Murswiek contended, arguing that that would be unconstitutional.”

(our emphasis)

As can be seen from this, the outcome of the constitutional challenge to the euro area bailouts in Germany is far from cut and dry. We will certainly keep a close eye on these proceedings and report on any important new developments that may happen.