Belmont Club

Evil Ways

European governments, faced with the need to raise more money than is available to stop the spread of the continent’s sovereign debt crisis, are considering borrowing against what they have to bulk up their defenses. The Wall Street Journal writes that this could take the form of expanding the European Central Bank’s balance sheet “by buying more debt or backing debt” or some other means. “The move could provide trillions of dollars of firepower to rescue governments and banks—-but only if all 17 euro-zone legislatures approve a two-month-old agreement to broaden the bailout fund.”


Apart from the doubtful wisdom of borrowing to pay for debt that you cannot pay, Deutsche Bundesbank’s Jens Weidmann reminded officials that leveraging the bailout fund, specifically by allowing it to borrow from the ECB, would be equivalent to the monetary financing of state budgets, which is forbidden by the EU treaty. But this difficulty didn’t prevent George Soros from arguing that new institutions were required to meet the crisis.

The original plan worked out in July, according to Canadian Business, and which was supposed to have been the last word, would had been to take a partial hit of the inevitable Greek default and then managing the consequences. “The July deal, which is still being negotiated with banks and investment funds, foresees a cut of 21 percent in the value of Greek government bonds — a haircut that most analysts say is way too small.” That approach still has support, but countries afraid that the resultant pain would stall economic growth at the wrong political time, either remained in denial or advocated borrowing on the existing bailout fund.

Germany, supported by Austria and the Netherlands, is now pushing for an “orderly default” by Greece, which would involve larger losses for Greece’s private creditors than foreseen in the July deal, said a European official.

A second official confirmed that a reopening of the July deal was supported by “the usual allies,” shorthand for other rich eurozone countries. Both officials were speaking on condition of anonymity because of the sensitivity of the issue.

The push does not yet amount to a clear plan, and the European Commission and the ECB are concerned that Germany may be overestimating the eurozone’s ability to contain the crisis, said the first official. “We don’t really have strong firewalls,” he said, adding that the crisis has already affected Italy and Spain.

Both IMF Managing Director Christine Lagarde and French Finance Minister Francois Baroin insisted at news conferences during the Washington meeting that the eurozone should stick to the July agreement — signaling further divisions over the best way forward.

Greek Finance Minister Evangelos Venizelos also ruled out a default, saying Saturday that his country was working hard on implementing the July decisions.  “Greece is never going to default because that would have been catastrophic for the euro area and for many other countries beyond the euro area,” he said in a statement.


But there is little real room to maneuver. Banks have expressed fears that governments are going to force them to take bigger haircuts than they have braced themselves for. Josef Ackermann, the outgoing chairman of the Institute of International Finance said, “if we now start reopening this Pandora’s box [the July agreement] we will lose a lot of time and I’m not sure people would be willing to participate.”

Like a man cornered at a roaring waterfall in a movie, faced with a choice between jumping into the rocky water far below or turning to face a voracious T-Rex hot on his heels, Europe stands poised on the edge. What is at stake is not simply whether the world enters a depression or recession soon: it is whether the old order survives.

As Ambrose Evans-Pritchard of the Telegraph put it, “Europe, the G20, and the global authorities have one last chance to contain the EMU debt crisis with a nuclear solution or abdicate responsibility and watch as the world slides into depression, endangering the benign but fragile order that has taken shape over the last three decades.”

Once again, the US has had to take charge. The multi-trillion package now taking shape for Euroland was largely concocted in Washington, in cahoots with the European Commission, and is being imposed on Germany by the full force of American diplomacy.

European Central Bank President Jean-Claude Trichet warned that Europe was only the tip of the iceberg. It would be wrong, he said to define recent events as an isolated European problem. It was now morphing into a global sovereign debt crisis, with consequences far worse than the the Lehman Brothers collapse. “What we are seeing now is the illustration of a global phenomenon, the global crisis of sovereign risk. Forgetting that the euro zone is at the epicenter would be a mistake, but forgetting that this is a global phenomenon would also be a mistake.” Singapore Finance Minister Tharman Shanmugaratnam, chairman of the IMF International Monetary and Financial Committee agreed with Trichet. “We face a confluence of sovereign debt and banking risks, with the epicenter of that being in the Euro area”.


Analysts likened it to a deadly merry-go-round and were looking for a way to jump off. “They’ve got to stop the self-fulfilling spiral between sovereign risk and bank risk. They need to break that feedback loop,” said Nick Stamenkovic, fixed-income economist at RIA Capital in Edinburgh. But was there any way out? The Wall Street Journal captured the thoughts running through the mind of the man at the waterfall’s edge by reporting that even as European officials writhed in an agony of indecision, the many and extraordinary philosophical musings being uttered by observers and officials.

“It’s a very small world now. We’re like mountain climbers. We’re all roped together and we want to make sure the rope is strong,” said Irish Finance Minister Michael Noonan.

“If we start now talking about further increasing, then it’s not realistic to have it approved,” Slovakia Finance Minister Ivan Miklos said of boosting the bailout fund’s size. “It’s counterproductive to hunt too many rabbits at the same time.” …

“When you are going for such a tough program, you have very strong contraction effects” on the economy, Portugal Finance Minister Vitor Gaspar said concerning the fiscal consolidation program proceeding in his country. “It is important to prevent the economy from going into a tailspin of contraction.”

“We can’t just go save someone. We’re not saviors. We have to save ourselves,” said Gao Xiqing, president of China Investment Corp.


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