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Euro policymakers, markets further apart than ever July 27, 2010

Posted by Yilan in EU, European Union.

EU flags are seen outside the European Commission headquarters in  Brussels November 27, 2009. REUTERS/Yves Herman/Files

EU flags are seen outside the European Commission headquarters in Brussels November 27, 2009.

Markets abhor a vacuum, and the perception gap between euro zone policymakers and financial professionals is almost certainly at its widest since the single European currency’s launch in 1999.

That is one reason why southern European countries’ bonds remain under almost as much pressure as they faced before the EU agreed on May 2 on a 110 billion euro bailout for Greece and a week later on a giant financial safety net for euro zone countries.

It also helps explain why interbank lending has dried up in some areas of Europe, with Iberian and Greek banks particularly dependent on the European Central Bank for refinancing.

Bankers and investors increasingly believe Greece is likely to default on its debt in the next three to five years, and many want Europe’s authorities to create an orderly restructuring process to share out the losses and avoid market panic.

Policymakers, on the other hand, believe any talk of default or restructuring is dangerous because it amplifies market panic, undermines the credibility of the currency area and may prevent Greece implementing the radical fiscal adjustment it has accepted.

That was a key dividing line between policy officials, academic economists, international financial veterans and market participants at a forum conducted under ground rules that preclude indentifying speakers.

In one forthright exchange, an investment manager said no investor with fiduciary duties would invest in a country like Greece that is forecast to have a debt of 150 percent of gross domestic product in 2012 and will need to convert a budget deficit of 13 percent of GDP last year into a 5 percent primary surplus to put its debt on a downward trajectory.

Markets were pricing in up to a 50 percent “haircut” on Greece’s sovereign debt, implying significant losses for the ECB and euro zone member states that have lent it money.

“We have 18 months to come up with a European debt restructuring mechanism before this problem is going to hit,” the investment manager said, accusing the ECB and the European Commission of ignoring the problem in their proposals.

A euro zone government policymaker responded that EU leaders had been clear that debt restructuring was “not on the table”.

“Maybe we are in denial, but suicide is not a good way to do business either,” he said.


Policymakers from the ECB, the European Commission and euro zone governments see the key to overcoming the euro zone crisis and restoring confidence mostly in strengthening and widening Europe’s fiscal rules and economic surveillance.

The likely outcome, one of them said, was that the euro zone would “muddle through” with adapted rules.

By contrast, market players, academics and international experts said the crisis had exposed fundamental design flaws in European Monetary Union which have to be addressed for the euro to retain credibility as an international reserve currency.

Among the flaws highlighted were the absence of a fiscal or economic union, the way cheap credit was allowed to fuel real estate and consumer booms in countries like Spain, Portugal and Ireland, and the failure of euro zone countries to think or act as a bloc in social, welfare or labour policies.

Speakers noted that Spain and Ireland, two of the countries hardest hit by the crisis, had respected all the EU’s fiscal rules until their real estate and credit bubbles burst in 2007.

Another big difference between market participants and the policymakers concerned the timetable for overcoming the euro zone’s turmoil.

European policymakers argued that turbulence should abate within weeks, once the European Union has begun to implement austerity measures, conducted transparent stress tests on its top 100 banks and shown that the European Financial Stability Facility backstop is up and running.

But several of the bankers and investors warned it would take years for confidence to return, once there was a clear mechanism for resolving the debts of insolvent states, a recapitalisation of banks found to be at risk and a longer-term backstop for euro zone debt.

Veteran former policymakers from the United States, Latin America and Japan were more optimistic about the euro’s survival and growth as a reserve currency than some European investors.

But they also expected the crisis to trigger bolder steps in European economic and fiscal integration than seem politically feasible in today’s Europe.

A Latin American central banking veteran of financial rescues, arguing against any early move to restructure Greece’s debt, likened the euro zone’s challenge to building a hospital.

“If you want patients to have confidence, you don’t start by building and showing off the morgue,” he said.



1. John Schroy - July 27, 2010

It seems to me that default on the debt of one or the other countries of the eurosystem is just one of the problems with regard to the euro.

There is the possibility, if push comes to shove, with the existence of multiple central banks in the eurosystem, that one day, somewhere, one of these central banks could just start printing euros (not banknotes) as paying agent for its local government.

See: http://capital-flow-watch.net/cjjkr (Do multiple central banks weaken the euro?).

2. The Soon Coming Collapse Of Credit Will Issue In Government Finance Where Only Food Stamps And Strategic Needs Will Receive Credit « EconomicReview Journal - July 27, 2010

[…] of financial rescues, who argued against any early move to restructure Greece’s debt at a forum of policy officials, academic economists, international financial veterans and market participants, […]

3. theyenguy - July 27, 2010

I believe that the EU sovereign debt and banking crisis will eventually trigger bolder steps in European economic governance than seems politically feasible in today’s Europe.

I comment on the analysis of the one Latin American central banking veteran of financial rescues, who argued against any early move to restructure Greece’s debt, who likened the euro zone’s challenge to building a hospital: “If you want patients to have confidence, you don’t start by building and showing off the morgue.” … My reply is that the EU state and finance leaders have agreed that there will no restructuring of the Greece debt at this time; never the less, I want to know where all the zombies are so I can see risk coming and avoid it.

Global debt deflation commenced on April 26, 2010 when the currency traders sold the worlds currencies, DBV, off against the Yen, FXY. This was just weeks after the Federal Reserve QE ended, and as the European Sovereign Debt Crisis was coming to a head.

Debt deflation is the contraction and crisis that follows credit expansion. One of the most famous quotations of Austrian economist Ludwig von Mises is from page 572 of Human Action: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

The greatest debt deflation came to the Russell 2000 shares, IWM and the European shares, FEZ.

As stocks, VT, rapidly fell in value, aggregate bonds, AGG, rose as a commonly perceived “safe haven” investment.

The apex in the chart of aggregate bonds, AGG, communicates” peak credit”; and that the “end of credit” will commence soon aided along by plunging values in the shadow banking system and failed US Treasury auctions.

Like forever, the Landesbanks, starved for yield in low-yield Germany, had been buying US home mortgages. Then with the repeal of Glass Steagall Act, both Wall Street and the Landesbanks began securitizing mortgage loans, that is packaging them in CDOs and offering them as highly leveraged investment vehicles. These had spectacular reception which were gobbled up by the German state banks as the rating agencies gave the CDOs and the underlying loans the very best of ratings. Then came the subprime crisis and an explosion of delinquencies on the mortgages followed by a rating downgrade (after the fact) which made the securities impossible to trade. So the Landesbanks took the mortgages off balance sheet and placed them in SIVs; and now are declining to publish details of their investments, as well as the details of the stress tests. This obscurity and opaqueness is the equivalent of a financial black hole at a time when transparency would be most helpful. Tyler Durden of ZeroHedge asks a very important question: Will The Record Plunge In Shadow Liabilities Impair Current Account “Shadow” Deficit Funding And Guarantee A Double Dip?

The past plunge and the continuing plunges in the Shadow Banking Liabilities, will result in a credit deflation and then liquidity evaporation followed by a credit collapse, propelling the world quickly into an age of zero credit, an age where seigniorage for credit will come from a combine of government and financial institutions, which I call Government Finance where only food stamps and strategic needs, such as military operations, will be issued credit.

Suggested Reading

Tyler Durden, ZeroHedge article Will The Record Plunge In Shadow Liabilities Impair Current Account “Shadow” Deficit Funding And Guarantee A Double Dip? … and

Ezra Klein of the Washington Post article 5 Places To Look For the Next Financial Crisis … and

Annaly Salvos, SeekingAlpha article NY Fed’s Paper On The Shadow Banking System Of Vast Importance … and

Possner Pinch Minyanville article Liquidity in Economy Never Higher, Yet Banks Growing More Illiquid relates: “Liquidity in the overall economy has never been higher, yet banks are growing more illiquid as they reach for yield. Loans aren’t liquid. Hedge fund investments aren’t liquid. CRE holdings aren’t either. Which leads to some interesting questions. If, as David Merkel suggests (rightly, in my view) that in this day and age monetary policy is synonymous with credit policy, how much looser can policy get? And given the implosion in lending that has happened in this economy, will anyone care?” …. I care because I am concerned the liquidity squeeze could like to liquidity evaporation thereby creating systemic risk ….. and

Andrian Ash, Daily Reckoning article Credit Deflation Lands In Britain relates how the UK is going to recapitalize and re-liquify its financial institutions

4. Polish Euro 2012 fan - June 15, 2011

Football is the best sport so you will necessarily have to see the european championship.

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