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Monday 23 April 2012
8:32PM BST 22 Apr 2012
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Another vast pledge to save the euro, another chance lost to break the hold of Europe’s austerity mystics and force a shift in strategic direction.
“We’re north of a trillion dollars,” said Christine Lagarde, the International Monetary Fund’s queen bee. Kudos to her for netting such sums in her Louis Vuitton handbag but what exactly does this achieve, given that Europe remains bent on committing “economic suicide” -- in the words of Nobel laureate Paul Krugman?
Big language from world officialdom had traction in the early phases of this saga, when episodic spasms of angst caused “sudden stops” in capital to the South – each quickly reversed by bazookas, firewalls, and solemn incantations.
Europe has by now progressed to the tertiary phase of its currency disease. A large chunk of global funding for EMU deficit states has been cut off indefinitely. There has been an almost irreversible collapse of investor confidence in the policy mix and governing machinery of monetary union. It is a “permanent stop”. Firewall can do nothing for this condition.
The IMF’s trillion talk merely encourages EMU and German elites to persist in their belief/dogma that the essence of this crisis is a speculative attack on the euro, and that defensive firepower on a crushing scale is therefore the solution.
United States curbs use of extra $430bn of IMF firepower
Chancellor defends £10bn IMF loan
IMF scratches at the surface of the eurozone debt crisis
Dutch government stands on brink of collapse
Britain pledges additional £10bn towards IMF war chest
Such thinking allows Berlin in particular to continue evading the uncomfortable truth that this mess is home-grown, stemming from massive trade and capital imbalances between North and South, compounded by the world’s most leveraged banking system with loan-to-deposit ratios of 1.3 – the same as Japan at top of the Nikkei bubble. (America is a sober 0.7).
There is little point rehearsing the stale debate over whether Club Med states are to blame for living beyond their means, or whether Germany is as much to blame for beggar-thy-neighbour mercantilism, and for flooding the South with excess capital. Both played a role, and much else besides.
What is clear is that these imbalances have built up to such a degree that the Greco-Latin bloc is now trapped in debt-deflation – like victims of the 1930s Gold Standard – with wage costs out of kilter by 20pc or more.
Equally clear is that Germany cannot cling to a structural trade surplus with all southern Europe in perpetuity, at least on this scale. The system has to balance over time. Germany must either give up its intra-EMU surplus, or furnish offsetting funds through capital flows or fiscal transfers, if it wishes to preserve the euro. It is the complete refusal of Germany’s governing class to face up to this dilemma that is now destroying monetary union. Firewalls are a decoy.
So EMU grinds on, a contraction machine for half a dozen countries, with France sliding slowly into this assembly of Miserables. To impose net fiscal tightening of 3pc a year or more on the South at this stage – without offsetting monetary stimulus or demand growth in the North – can lead only to a downward spiral that engulfs everybody in the end.
“Rather than admit that they’ve been wrong, European leaders seem determined to drive their economy — and their society — off a cliff,” said Professor Krugman.
Hopes that structural reforms in Spain, Italy, Portugal, and Greece will save the day are likely to be dashed on the jagged reefs of politics long before any benefit is visible, a decade hence at best.
The Flores de Lemus Foundation thinks Spanish unemployment will reach six million by next year, or 26pc. The regions will bear the brunt of cuts, and there lies a political minefield since Catalan nationalists are convinced that the Partido Popular of Mariano Rajoy is exploiting the crisis to reorder Spain’s constitutional landscape. This adds nitroglycerine to the mix.
In Greece, investors fret over whether Pasok and New Democracy can between them muster a governing coalition willing to comply with the EU-IMF “Memorandum”. We will find out in May, but it is a red herring in any case. Even if they can form a government, they must agree to cuts equal to 5pc of GDP for the 2013 and 2014 budgets by a deadline in June, and then start delivering on these cuts. Pasok leader Evangelos Venizelos is already asking for an extra year.
These fiscal targets will not be met. The slippage will be so obvious within months that German and Dutch patience will snap. And then what?
In France, the austerity debate is at least joined. François Hollande has forsworn the EU fiscal compact and called on the European Central Bank to underwrite Club Med bond markets – with the risk squarely on its own balance sheet. He has stiffened his rhetoric after losing support to crypto-revolutionary Jean-Luc Melenchon, whose vow “to smash the Merkozy axis” has struck home on the hustings.
Whether Mr Hollande has the imagination or mettle to break the half-century mould of EU politics and lead a “pro-growth” Latin revolt remains to be seen. Events may precipitate rupture in any case if his other-worldly policies – including a CUT in the state retirement age to 60 – sets off the sort of speculative attack seen when François Mitterrand won in 1981. The Paris bourse fell 18pc the next day. Stress today would surface in the bond market, where France has no margin for error.
Italy and Spain have already lost that margin. Pimco’s Mohamed El-Erian is still buying their debt – or claims he is – but most `real money’ behemoths, from Japanese life insurers to petro-wealth funds, have made a strategic decision to stay clear until EU leaders either “put up” with genuine fiscal union, or `break up’ with a cathartic release from the current hopeless state of affairs.
In such circumstances, incremental rescues by the EU and IMF are worse than useless. By refusing to take loses themselves they subordinate other creditors, pushing them deeper into “mezzanine status” with each intervention. This is no longer theoretical after Merkozy’s 75pc haircut for holders of Greek debt, many of them pension funds who purchased in good faith. Expropriated once, shame on you. Expropriated twice, shame on me.
Spanish and Italian banks are now sole chief buyers of their own countries’ bonds, playing the “carry trade” with money from the ECB’s three-year loans. This is a dangerous game. The latest surge in yields leaves many sitting on paper losses that they may have to crystalize.
Week by week, the fortunes of prostrate states and prostrate banks are becoming more intimately entwined. Systemic risk is rising by leaps and bounds.
This is not to criticize the ECB’s Mario Draghi for his blast of liquidity. He had no choice. The Club Med banking system was disintegrating last November. But piecemeal intervention – or “limited and temporary”, as he puts it – is self-defeating.
Central banks have to take the risk onto their own balance sheets, not fob it off onto distressed lenders. They must act with overwhelming force, taking the possibility of sovereign defaults off the table entirely.
The ECB has not done so. Doubts are fanned daily by the Bundesbank. The body-language is awful. And hawks are already itching to tighten again, an astonishing prospect given the collapse real M1 deposits across the eurozone’s arc of depression – now falling at double-digit rates even in Italy.
China, Japan, America, the oil powers, and the rising economies of Latin America had a chance to pull Europe back from suicide through IMF pressure. The world dropped the ball.
In Ambrose Evans-Pritchard
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