02 July 2012

Eurozone: This time is different, or is it?

Thursday, Germany lost twice against the Italians: once for the euro 2012 soccer cup semi-final and then, later during the night, when the Italian PM Monti’s (and Spanish PM Rajoy) blitzkrieg won over frau Merkel. He played tough by simply refusing to sign any agreement until Germany agreed that the eurozone must jointly back Spanish banks without Spain having to guarantee the deb.
1. The agreement
  • setting up a single European supervisory mechanism for banks under the ECB control
  • ESM allowed to directly recapitalize banks
  • Possibility for countries which are complying with common rules, recommendations and timetables, to make use of the existing EFSF/ESM instruments to stabilise markets. Financial assistance to Spain will be provided without seniority status for the financing provided by the EFSF/ESM.
  • mobilizing around 120 billion euro for growth measures:
    • A 10 billion euro increase of the capital of the European Investment Bank implying a lending capacity by 60 billion euro.
    • The other 60 billion euro comes (i) from the reallocation of unused structural funds (55 billion), and (ii) from the pilot phase of Project Bonds to be launched this summer and targeted at key initiatives in energy, transport and broad-band infrastructure (4.5 billion).
  • Adopting a Financial Transaction Tax by December
2. What’s next?
Ireland must rejoice since they now can lineup to require the same favorable treatment, which cost is put at EUR 64 billion.
European (read mostly EZ) taxpayers are on the hook thanks to the pan-EZ mutualization of the European banking sector rescue. Do not misread me, I strongly believe that for a monetary union to survive (if not thrive) the banking sector MUST have a single supervisory board and the costs must then be shared. However, we are mutualizing liabilities before having had any chance to mutualize benefits (and will probably share none, if any in the future) at nil cost for banks; in a capitalistic environment, the ones who rescue an ailing company take control: nothing near this simple and sensible criteria here… I also notice that no FDIC equivalent is set up to guarantee deposits with no limit on the number of accounts guaranteed one can hold.
The question remains: is this the first step towards the mutualization of sovereign debt? I cannot believe that Germany would carve in; if they do, the credibility of Europe would be jeopardized.
The direction towards fiscal integration is going ahead but many obstacles remain which let me think that the success is far from being certain (I am in fact very doubtful).
Fiscal union without social union will fail as the EZ failed (whatever politicians do to disguise it, it is a failure). The EU loves, and writes in many of its statements, the words “best practice”: ask the French if best practice is 67 years old retirement age, no minimal wage, 40h a week working time, etc.
What last week agreement achieved is reassuring markets for some time by reducing the amount of money Club Med countries will devote to save their ailing banking sector: Spain has gone from 100% down to 12%. Conversely, France is adding EUR 20 billion of liabilities. Remember my words for a rather long time, France is really sick economically and worse than Italy. Today, the French Audit Court is publishing a report that I will carefully read; the first comments are rather straight to the point: EUR 40 billion need to be found until end 2013 to abide by France’s commitments on deficit reduction…
Markets will however go back to the reality of the EZ: a monetary union with a widening competitiveness gap. NOTHING, I repeat nothing, of what was decided last week is addressing this gap; the EUR 120 billion to spur growth via infrastructure investments, particularly in distressed European countries, will take years to bear fruits and 1% of EZ GDP split over 5 or 10 years, with nearly nothing in 2012-2014, is not going to help them drive their way out of recession.
The core of the problem is still pending: lack of competitiveness of Southern Europe versus Northern Europe. As a matter of fact, French will never accept a 25-30% decrease in wages to become competitive again: understandably they will always prefer a currency devaluation than a salary devaluation (and no, the effects are not the same for the population concerned).
Yes, this time is different because Germany bent before blackmailing, but no, it is not different because the roots of the problems remain: lack of competitiveness and structural trade deficits that act as a drag on growth which is the only way out of the crisis. The necessary structural adjustments (lengthening of working hours, postponing the retirement age, reducing the share of the public sector in the economy, etc.) will only be accepted by the population if there is some form of growth. Austerity to bring public finances under control without devaluation is a death spiral – see Greece.
As reported by Bloomberg: “the EU’s two rescue funds may only amount to about 20 percent of the outstanding debt of Italy and Spain, limiting the ability to lower the nations’ borrowing costs.”, not mentioning France.
European Council 28/29 June 2012 – Conclusions
Remarks by President Herman von Rompuy following the European Council

Bloomberg: EU Leaders Ease Debt-Crisis Rules on Spain