As we all grapple with the possibilities inherent in the almost certain dismantling of the Euro as we know know it, it behooves us to consider certain realities. For all the supposition, there is a reasonably cogent way to view this, based on what has actually occurred and what may be likely as a result. Therefore, please consider:
- Angela Merkel has 'officially' floated the notion of "More Europe". I believe this will prove to be a critical inflection point.
- The ECB has steadfastly, forcefully and loudly stated its opposition to ANY 'monetization' of the Euro Crisis.
- The EFSF 'option' is dead on arrival.
- Italian, and other important sovereign spreads, have re-widened today.
- All the not-yet in Crisis 'Core' nations are feeling the pressure, politically and otherwise.
Let us now consider the aforementioned one at a time.
Ms. Merkel has publicly debunked the notion of a potential sole German breakaway by labeling the solution as, "More Europe". I believe this re-framing represents a seminal momeent in the Crisis and holds the key to the solution. I further believe Germany is planning to lead the 'Core', non-profligate States to a new Euro. This will be accomplished in a pragmatic, well-reasoned, highly calculated launch. And soon.
The needed political and public relations 'cover' is straightforward. The "More Europe" concept is very simply rooted in a return to and reaffirmation of and adherence to the original Eurozone mandates. Those mandates have a convenient 'built-in' control on fiscal adherence, and by extension, permanent controls on sovereign debt issuance and ratios.
Those that 'qualify', obviously including Germany at the head of the line, will be in. Those who do not, will be left out; but not abandoned. Simply relegated. For, I believe, there will be a Euro IA for the peripherials. There will also be a mechanism whereby the outliers can qualify for re-admission to the "Premier League", "Ligue I", "Bundesliga", or your choice of Euro-Football referenced promotion protocol. Europe does love its 'football' after all. Staying with the 'Fussball' analogy, there will also be a relegation procedure for any 'Originals', who cannot or will not march in a fiscally responsible line.
Readers may now wonder who would be League 1 or League II. I believe that is a relatively straightforward list, in both cases. I am convinced that France will be invited in the 'top-flight', but must fudge enough numbers by the end of Fiscal 2013 to provide cover for the 'hey, wait a minute' crowd.
Now to the ECB. And funding this 'fix'. I will take Mssrs. Draghi, Stark, Paramo, et al at their loudly stated word. No monetization. PERIOD. Just stop at the ECB mandate. The ONLY mandate they have. Control of prices.
With that out of the way, we can focus on the funding. Let us consider the problem, the end game and the numbers. Continuing to shovel coal into the endless furnace of market support for the challenged sovereigns is becoming more and more of an impossibility, by the day. The losses on the 'portfolio' the ECB has amassed are already considerable, and we all know who ultimately absorbs them all. Not to mention the small problem of the program not working, as multiple targets are breached continually. Trying to outlast the bond market without a fully functioning printing press is a fool's errand.
The ECB is essential in any implementation of the 'dual Euro'. There will be a 'record date' established whereby current Euros are exchanged for a pre-determined allocation of Euro I and Euro IA. This will operate in a similar fashion as the original exchanges occurred back in the day. All participant currencies were 'exchanged'. To prevent rampant speculation there must be a 'stand-by' of some magnitude and a pledge from Euro I domiciled banks to hold Euro IA. They will still have market share in both 'zones'. It should all be reasonably orderly, particularly as the 'relief factor' is realized, and the reality of proper re-calibration of both versions takes hold. Of course, none of it is fool-proof and eventually the markets will dictate the levels. The ECB can administer both. After all, do not Central Banks routinely operate in many modes and in multiple currencies?
Lastly, there is a very little talked about fact, which is very important to the future of Europe, and dispells many wonders regarding that future. That is, the new ECB edifice, some would say "monument", which the ECB is currently constructing after much delay. At close to 1 billion Euro and counting, it has been in development/construction since 1999, when the competition was announced for the design of the complex. The city this will be located in? You guessed it, or knew it, FRANKFURT. Just as the present ECB is domiciled. To me, this means the ECB is there to stay, for many decades to come. Smack in the middle of Germany. This is as important to the ultimate 'fix', as any single factor. In my mind, anyway.
The EFSF was to be the ultimate instrumentality of the previous version of the 'fix'. One element of this part of the 'plan' I never reconciled, besides the obvious questions of leverage and partial 'guarantees', was the expected credit rating for this contraption. As S+P clearly stated this past summer it would expect to rate any European credit rescue facility to reflect the lowest rated participant's rating. The precedent for this 'weakest link' methodology is well established. Many multi-participant credits are assessed in this manner. So, for me, the question became, since Greece was obliged to participate in the EFSF funding by 2015 (I believe), and would contribute 15 billion Euro (I believe) from proceeds of asset sales by then, should the EFSF be rated as Greece is rated, post re-structure? I cannot imagine how low that rating would be, but it is safe to say a below investment grade would likely be in the cards. Oh well, those pesky details. That was then, this is now. I still cannot figure this out.
But it matters not. For the EFSF came to market early last week to 'test the waters'. How did it do? Not too well. The EFSF not only paid a 3.59% yield for a ten year term ('only' 179 basis cheaper than their AAA bretheren in Germany were yielding at the time!), demand was so tepid, EFSF itself had to resort to supporting its own deal to the tune of 'several hundred million Euro' in purchases. This is besides the fact that the total raise was curtailed substantially. Purpose for this issue? To support Ireland, a name which has been almost completely off the radar screen, as the focus on Italy has escalated.
I guess with more leverage, S+P, or the other services, may consider a new rating designation for the EFSF. Can history's first AAAA+ credit rating be that far away?
I believe the EFSF will have very little role in the 'fix', unless a major re-structuring of the EFSF itself is undertaken, by the then strongest participants.
Italy and Other Sovereign Yield Spreads
Spreads continue to widen. The closely followed Italian 10 yr has gone back above 7%, after a short-lived boost last Friday. Additionally, other spreads, most notably France's, continue to diverge from German benchmarks.
Political Pressures in the Core
Merkel under the gun, Sarkozy up for re-election, other leaders fretting, the political situation on the ground in the core of Europe is deteriorating. You know, those few still solvent. Parliaments are vocally drawing harsh lines, and leaders, quite naturally, are paying heed. Was it not Ms. Merkel and Mr. Sarkozy themselves, who ostensibly affected changes in Greece and Italy. They must be wondering about that 'goes-around, comes-around' syndrome, 24/7.
As I have observed all of this incredible living history, I have had much evolution of thought. I have changed my mind along the way, as more has been revealed to me. My current belief is that Germany will leave the current construct of the Euro, along with a select group of nations. Sort of a "Good Sovereign/Bad Sovereign" concept. A concept which has become too familiar to all of us. Crisis has a way of 'branding' certain concepts, does it not?
I believe something along the lines I have described will be the cheapest, most politically expedient, most widely accepted solution possible. Will some variants appear. Most certainly. But this will be close to what emerges. It has to happen. And it has to happen soon. Look at today's U.S. equity markets. As soon as Fitch hinted that U.S. banks could see rating pressures, should Europe not be resolved soon, we tanked. How much aggregate 'market cap' was wiped out? A bunch. All in a matter of minutes.
Let us not forget that the Germans are highly motivated, as are others in the 'Core' and elsewhere. They will be precise and carefully plan and craft it all.
We may just end up with a 'semi-orderly' break-up. If we are lucky.
No, make that VERY lucky.