Cacophonia, Part Umpteen - Finland to 'Prepare for Euro Break-Up'
The Fins have the right idea - better prepare for the worst. Foreign minister Erkki Tuomioja (say that ten times fast) says the time to think about and prepare for a euro area break-up is nigh.
As Edward Hugh recently pointed out to us, Finland would actually be a prime candidate for a voluntary exit from the euro - it can afford it. In that sense Tuomioja's words have a somewhat ominous ring to them:
We have to face openly the possibility of a euro-break up. It is not something that anybody - even the True Finns are advocating in Finland, let alone the government. But we have to be prepared. Our officials, like everybody else and like every general staff, have some sort of operational plan for any eventuality.
To this it should be noted that quite often the things that governments prepare for later become reality precisely because such a nice, detailed preparation for them exists. Why let a good plan and preparation go to waste? World War One was a prime example for meticulous preparation before the fact. All the generals and their staffs everywhere in Europe had their deployment plans down pat - to the minutest details.
An interesting aspect of the Telegraph article on the growing political pressure in Finland - where the established mainstream parties see their support seep away to euro-skeptic "fringe" parties like the True Finns (no longer fringe, actually) is the following train of thought. It starts with the leader of the True Finns bemoaning the existence of the euro and lamenting about the straitjacket it has put everybody in:
"Taxpayers here are extremely angry," said Timo Soini, the True Finn leader. "There are no rules on how to leave the euro but it is only a matter of time. Either the south or the north will break away because this currency straitjacket is causing misery for millions and destroying Europe's future. It is a total catastrophe. We are going to run out of money the way we are going. But nobody in Europe wants to be first to get out of the euro and take all the blame," he said.
So notwithstanding the many angry taxpayers in the arctic, nobody wants to get out of the euro for fear of being blamed for breaking it up - sounds reasonable enough.
Then the article mentions the upcoming (early September) troika visit to Greece and the growing likelihood that Greece simply won't cut it this time, as creditors have evidently had it with throwing more good money after bad. Note also Finland's rather adamant refusal to alter ESM seniority over existing bondholders, which seems to plainly contradict the recent ECB announcement.
"The issue of euro break-up may come to a head in October as EU-IMF Troika inspectors report back on Greek bail-out compliance. Pleas from Athens for two extra years to stretch out its austerity regime have run into fierce resistance from creditor powers.
"It is up to Greeks whether they want to stay in the euro," said Mr Tuomioja. "We cannot force Greece out. We can cut off lending and that would lead to a default. Then we could speculate whether that would entail getting out of the euro. Nobody knows if it could be contained," he said. Mr Tuomioja said Finland would block attempts to strip the European Stability Mechanism (ESM) or bail-out fund of its senior status at the top of the credit ladder, a move that could greatly complicate efforts to lure investors back into Spanish and Italian bonds. "The ESM loans have priority. That is a red line for us. We are very concerned that the rules of the ESM seem to be changing."
It follows from this that if Greece is forced into default and subsequently exits the euro, the dam will have broken - from that moment on, exiting the euro will no longer be taboo, because one member would have actually done it. It won't matter that it happened under duress - we actually believe it would be like the pistol shot at the start of a race.
It seems quite likely that the eurocrats realize that. When Mario Draghi proclaimed the "irreversibility" of the euro, one of the journalists at the Q&A asked him to elaborate a bit on that statement. Draghi's reply: "It means exactly what I said. The euro is irreversible. There won't be any going back to the lira, or the drachma."
We have wondered ever since why the lira and the drachma specifically were singled out. It may mean nothing - perhaps he just uttered the names of the first two legacy currencies that came to his mind - but even so it is interesting that the drachma rated a mention. Let us not forget that while the "troika" (of which the ECB is part) deliberates and delays, the ECB actually helps to keep the Greek government and the Greek banks just above the waterline - mainly with the help of ELA (emergency liquidity assistance), which is inter alia used to enable the Greek banks to buy the government's t-bills so it has some spending money until the troika gives its placet to releasing further funds under the bailout agreement.
We have described this particular trick before, but here is a quick reminder: officially, the ECB is not allowed to fund governments. So the way it gets around that restriction in Greece's case is that the Bank of Greece prints up whatever amount is required (after getting the nod from the ECB), then stuffs the banks with this money, which in turn buy the t-bills the government auctions to them. The government then - and that is the truly funny part - pays the money back to the ECB to redeem a few billion euros in Greek bonds the ECB holds and that are coming due. Can you say sleight of hand? This is how the modern-day fiat money Three Card Monte works. Now you see it, now you don't…and somehow, the clearly insolvent Greek government lives on to fight another day and can continue to pretend its is actually solvent - even if things are pretty tight at the moment, as indicated by a "spending moratorium" the government has just declared.
Let us return to the colorful Mr. Tuomioja though - what he said next really brightened our day:
He voiced deep suspicion of plans by a "gang of four" EU insiders - including the European Central Bank's Mario Draghi - to ensnare member states into some form of fiscal union. "I don't trust these people," he said.
Well, the "gang" shouldn't be trusted, that's for sure. As to the identity of the other three members of the "gang of four" we would guess: Herman van Rompuy, Manuel Barroso, and J.C. "we lie when appropriate" Juncker.
So far the Fins have always come around, but they have tied their aid to conditions such as demanding collateral, which is certainly a wise course. They may not sit idly by if the bailout strategy becomes too drastic for their taste.
Merkel In 'Full Support' of Draghi
On the other end of the cacophony see-saw we find Mrs. Merkel this week, who once again voiced her 'full support' of the European printer-in-chief's latest plans, urging European leaders to "move swiftly" regarding "closer integration of fiscal policies" in the euro area.
The usual "time is of the essence" blather, which we have heard so many times before (anyone recall Olli Rehn's "we have ten days to save the euro"? That was ten months ago. Somehow, the world is still turning).
Interestingly, these remarks were made during a visit by Mrs. Merkel to Canada and she used the occasion to compliment Canada on its somewhat better fiscal position and the policies that got it there.
Merkel, facing European pressure to ease bailout terms and allow shared debt, and from global partners to do more to stop contagion, used a visit to Canada as the stage for her first public comments in a month on the crisis
"She hailed Canada's budget discipline, promotion of economic growth and "not living on borrowed money" as models for the 17-nation euro region.
You can immediately tell that she obviously doesn't understand what caused the crisis, otherwise she may not have been so eager to heap praise on Canada. After all, Canada has a housing bubble that is enough to make one dizzy (scroll down to what's listed at $1.18 million in Vancouver) and has a population largely buried under mountains of consumer debt. Moreover, its economy remains highly dependent on the resources boom, which is to say, on China (enter the fear strings).
Granted, when Ottawa was faced with the need to get its fiscal house in order in the 1990s, it succeeded admirably in doing so. Also, its banks are widely hailed as being more solid than their counterparts elsewhere, but we frankly don't take such assurances seriously - they are fractionally reserved banks after all, so they may well look like they are in ruddy health while the boom keeps going, but that could change in a heartbeat.
What will happen if one or more of the props that keep the bubble going should give way? We would suggest that the fact that a state-owned mortgage insurance company is the exclusive insurer of the towering mortgage debtberg in Canada, the government's finances could well be shot to hell in no time at all once the boom turns to bust. A study last year found that about a third of Canadians are overwhelmed with worries over their financial situation and have sleeping problems because of it. Too much consumer and mortgage debt is evidently the culprit.
This brings us back to what Mrs. Merkel fails to understand: it is the fractionally reserved banking system, aided and abetted by the central bank, that has caused the crisis by vastly expanding the credit and money supply in the euro area in the first decade of the euro's existence. Let us say that the austerity drive works (i.e., turns out to be politically doable against all odds), markets calm down again and banks and borrowers regain their confidence and the credit expansion continues where it left off. For a while, everything will look fine again. Government tax revenue would increase, interest rates would likely remain low for some time, a new boom might well begin - and it would likely once again be an uneven affair, with the banks in some countries expanding credit more than in others and creating commensurately more intense boom conditions. At some point the ECB would - per its mandate - tighten policy again, and yet another boom would ultimately end up unmasked as a period of false prosperity. The crisis would begin all over again, only perhaps with a different set of major protagonists.
As it were, Mrs. Merkel went whole hog at her press conference in Ottawa:
"I made clear once again that we need a long-term, sustainable solution," Merkel said at a joint news conference with Harper in the Canadian parliament building.
"It is a question of taking the steps that weren't taken when the currency union was created, namely a political union," she said.
Good grief! A political union? Give up the subsidiarity principle completely? Pigs will fly and hell will freeze over before that happens - we hope.
In the meantime, Mrs. Merkel's pithy piling on of European unity hallucinations served to calm the credit markets in the euro area and elsewhere further, inviting more risk-on behavior by market participants. Except where it didn't of course, such as in Slovenia.
But who cares about Slovenia, right? Most people can't even find it on a map after all. However, small though it may be, it appears to be bailout candidate number six. One wonders when there will be more bailout candidates than nations left to bail them out.
Credit Market Charts Selection
Below is a selection of our customary update of credit market charts: CDS on various sovereign debtors and banks, bond yields, euro basis swaps. Charts and price scales are color coded (readers should keep the different price scales in mind when assessing 4-in-1 charts). Where necessary we have provided a legend for the color coding below the charts. Prices are as of Thursday's close.
Due to the still persisting Draghi afterglow, which Mrs. Merkel's remarks rekindled, all seemed well again in euro credit-land.
Obviously, there is one rather glaring exception - namely Slovenia, where the prayer beads are presumably polished and ready for action by now.
CDS on Italy and Spain are back at their June lows, which is so to speak a return to the happy days of June…or were they happy? Most other CDS on euro area sovereigns (Greece is a perennial exception, but it's hardly worth mentioning anymore…) are decidedly lower than they have been earlier this year. Many are in fact at lows not seen since mid 2011. As we often point out, differentiation increases whenever the crisis pauses.
As we have also mentioned earlier this week, the month of September harbors a great many potential pitfalls. "Sober Look" was so considerate to make a list of them.
It has also come to light recently that the borrowing of the Spanish banking system from the ECB keeps soaring into the blue yonder and has reached a new record high of nearly €376 billion as of July. We have little doubt that some of that money has once again found its way into Spanish government bonds.
5-year CDS on Portugal, Italy, Greece and Spain
5-year CDS on France, Belgium, Ireland and Japan
5-year CDS on Latvia, Lithuania, Slovakia and Slovenia (ouch!)
Our proprietary unweighted index of 5-year CDS on the senior debt of eight major European banks (BBVA, Banca Monte dei Paschi di Siena, Societe Generale, BNP Paribas, Deutsche Bank, UBS, Intesa Sanpaolo and Unicredito - white line), compared with 5-year CDS on the senior debt of Goldman Sachs (orange), Morgan Stanley (red), Citigroup (green) and Credit Suisse (yellow) - somewhere between easier and mixed
Three-month, one-year, three-year and five-year euro basis swaps - the three-month one has made it back to the levels of July 2011
10-year government bond yields of Italy (generic bid price, generic gross yield is at 5.85%), Greece, Portugal and Spain - mostly easier, especially Spain's bond yield
Via CLSA: foreign currency reserves of the SNB - don't worry, nothing bad can possibly happen