I wrote back towards the end of last year after the Ireland crisis the following paragraph:
“the Euro as a currency faces some serious challenges because by definition, the strong need to support the weak. However how much longer can the strong remain strong? Germany, and the rest of the relatively more ballin’ (ISBA: solvent) EU nations are rapidly overextending themselves and if there is the slightest chink in their armor or questions surface about their Government’s balance sheets then boom, fffssssssssssssssssssssssstttttttttt. Flaccid sex doll.”
There are punctures appearing in the sex doll of confidence. While Greece, Ireland, and Portugal have had to agree to pretty significant austerity measures, they have definitely been given preferential treatment. Greece can borrow for the next decade at under 4% guaranteed, and Ireland and Portugal will also have low interest rates for extended periods (though not as long as Greece). These loans are furnished by an entity called the European Financial Stability Fund (EFSF), which is in turn guaranteed by the members of the Eurozone. The issue is that when a country gets in trouble, in this case if they are facing higher borrowing costs than those who they are bailing out, they can “step out” on their guarantees and are no longer responsible to back stop loans doled out. So stepping out is fine for small countries like Greece, Ireland, and Portugal, cause… well…. They aint providing shit for backstopping loans anyways, but if Spain and Italy continue with their current crisis level of debt (and current interest rates at 6+%, which is higher than those being bailed out) and also step out as guarantors (they currently total approximately 30% of the guarantees), then you’re left with pretty much France and Germany backstopping everything and struggling mightily to keep their own AAA rating. FSHHHHHHHHHHH see the holes in her shitty and the domino effect?
Speaking of France, while all the rating agencies have confirmed its AAA status recently, France’s debt is more expensive to insure than lower rated governments like Malaysia, Thailand, Japan (who was downgraded again yesterday), Mexico, Czech Republic, and the US. If you look at the debt numbers too, France is not ALL that different from much maligned Italy (and its debt growth rate is higher) yet Italy is rated 4 notches lower at A+. France also has had a larger budget deficit than Italy every year since 2006. So the status of France as a “core” nation is hugely at risk, even further so if their contingent liabilities get jacked up by other guarantor nations stepping out. If France was to lose its AAA rating it would likely find itself in a situation similar to Italy and Spain above of having borrowing costs higher than the countries it is bailing out, making it a candidate to step out as well leaving pretty much…Germany. Germany by itself is totally unable to handle this whole backstopping business as the Italian debt is roughly equal to its own GDP.
So what to do then? The EFSF is inherently unstable and unable to help if the debt crisis spreads to the core of the Eurozone. The next option many people have proposed is Eurobonds. Eurobonds would be bonds issued to investors that have the implied backing of the entire EU, the way US bonds have the backing of all the individual states. The issue with this though is that where the US is a political union, the EU is not. Holding taxpayers in solvent and legit countries accountable for decisions made in fiscally wild and hedonistic countries is a recipe for raining fists, especially considering heightened tensions in the whole region recently.
Plus the Eurobonds would violate a “no bail out” clause in the Lisbon Treaty signed in 2007 between the member states. Har har har you say, there have been bailouts going on for YEARS in Europe, they have a no bail out rule??
Yep. The way the EFSF got around this clause in the first place was that lawyers ruled “no government MUST be liable for another government’s debt, but if they CHOOSE to help each other, then that is TITSTACULAR” (emphasis mine). But since the Eurobonds would likely increase Germany’s overall borrowing cost (cause they are adding the risk of all the shitty parts of Europe onto their own), Germany is this case is saying “NEIN!!” placing it in violation of the clause.
So Eurobonds are likely out, for a possible solution we turn to the wonderful folks at the Center for European Policy Studies, who regularly knock it out of the park with slightly outside the box thinking. They propose turning the EFSF into a special purpose bank, rather than just a fund like it is now. This bank would then have access to European Central Bank funding in the case of an emergency (like all other Euro banks do and American banks have access to the Federal Reserve).
This magical bank would have two departments.
- One would facilitate orderly debt restructuring for those nations that required it (backstopped by all members of the Eurozone)
- The second would buy government bonds from troubled countries to facilitate liquidity when the situation required it. For smaller countries (like Greece, Portugal, etc), the normal resources of this bank would be enough to solve the issue, but for giant liquidity crunches (like the ones faced during 2008 and…. possibly 2011), the bank can go to the ECB and borrow from it using the government bonds it has bought as collateral.
My favourite part of this plan is that it solves what I brought up in the Greece post: that you are not lending more to a country that is insolvent, but lending only to a country that needs liquidity. See if this bank is going to borrow from the ECB, they need to post collateral for it and they’ll do this with the government bonds that they have bought (see above). However the ECB isn’t going to accept government bonds from some Banana Republic, B rated, pile of lose, they will only accept very high quality bonds as collateral. So the countries credit rating needs to be intact in order to have this bank access the ECB for liquidity on its behalf. So fiscally unstable countries go to department one for an orderly default (sorry but it has to happen for capitalism to function, losers have to lose, at least this way it is set out how it will happen), and fiscally solid countries suffering from liquidity crunches have access to the funds they need to tide them over.
I love that idea, will it happen? Who the hell knows. Currently Eurobonds appear to be the flavor du jour, but there is A LOT of political opposition from ze Germans, who are looking like one of the last good apples in a whole Tupperware container of butt soup.
Till next time
The SRB (a.k.a. The dismisser of the box)