Monday 27 March 2017

Without politicians, a €3tn 'bazooka' might work

THE leaders of the world's 20 largest economies meet at Cannes in just over a month's time. With markets looking to the G20 meeting for a solution to the long-running euro crisis, just what can we expect from the Riviera knees-up and will it finally solve the crisis?

The writer Graham Greene once famously described the Riviera as "a sunny place for shady people". We mere mortals can only hope that, when the G20 meets at Cannes on November 3-4, the light will prevail over the shade.

Two years after the scale of Greece's financial problems first emerged, it is now clear that the EU's favoured policy of "extend and pretend", is no longer working. The markets are now demanding a comprehensive solution. If they don't get it then the single currency is almost certainly doomed in its current form.

In an ideal world the solution to the euro crisis would be to underpin European monetary union with European fiscal union. This would see the creation of a single eurozone treasury with the power to dictate public spending and taxation levels in each of the 17 member countries.

A single eurozone treasury would also be able to issue "eurobonds" guaranteed by all of the member countries. This would, at a stroke, slash the borrowing costs of peripheral eurozone countries such as Ireland, Greece and Portugal.

While eurobonds hold many attractions, German objections almost certainly render them politically impossible. Europe's largest economy worries, probably correctly, that implicitly guaranteeing the bonds of peripheral eurozone countries would cost it its cherished triple-A credit rating and push up its own borrowing costs.

With eurobonds off the agenda and both the United States and China having made it clear that continuing with the current "do-nothing" policy is no longer acceptable, Europe's leaders seem to be gradually inching toward Plan B. This would involve leveraging the European Financial Stability Facility (EFSF), aka the bailout fund, thus increasing the resources at its disposal from the current €450bn to €2 trillion.

If the associated IMF facilities were also leveraged in this way it would create a €3tn war chest to defend the euro.

A beefed-up EFSF would be able to intervene in the markets to buy up not just Irish, Greek and Portuguese bonds but also those of Spain and Italy. It would also be able to help recapitalise the French and German banks.

French banks hold more than €40bn of public and private Greek debt on their books and a massive €540bn of Italian and Spanish debt, while German banks have about €25bn of Greek debt and about €250bn of Italian and Spanish debt on their books.

This means that all of the major French and German banks are effectively bust. The combined market capitalisation of the three largest French banks, BNP-Parisbas, SocGen and Credit Agricole, is now less than half of that of luxury scarf manufacturer Hermes, while it has been estimated that recapitalising the major German banks would cost at least €125bn.

With the imminent threat of sovereign default on the periphery and a worsening banking crisis at the core, the problems facing the eurozone are critical. However, despite the severity of the problems a €3tn EFSF/IMF rescue fund would scare off even the most determined speculators. Taking it on would be the financial equivalent of getting into the ring with an 800lb gorilla.

Unfortunately, while there is little doubt that a €3tn rescue fund for the eurozone would do the trick, this doesn't mean that it's going to happen. While this week the German parliament, the Bundestag, finally voted in favour of the July 21 deal between eurozone leaders allowing for an increase in the EFSF to €450bn, hopes that this may be precursor to securing German agreement for a €3tn fund are almost certainly premature.

Even if the German Chancellor Angela Merkel and her finance minister Wolfgang Schauble (whose uncanny physical resemblance to TV's Father Jack increases by the day) can be persuaded of the merits of such a scheme, convincing German public opinion may prove to be a very different matter.

Large sections of Merkel's own CDU/CSU are already unhappy with the July 21 deal while Andreas Vosskuhle, president of the German constitutional court (which reluctantly approved the July 21 deal), has warned that Germany is approaching the limits of what can be done without a constitutional amendment, something that would have to be approved by a referendum.

If the July 21 deal is already causing such misgivings in Germany, then the odds of Europe's paymaster going even further must be remote.

And it isn't just Germany.

Taoiseach Enda Kenny, making a virtue out of necessity, has already ruled any treaty changes to solve the eurozone crisis. Given the widespread public anger at the terms of the November 2010 EU/IMF bailout deal, the chances of the Irish electorate ever approving an EU treaty again are somewhere between very slim and none whatsoever.

However, much the rest of the developed world must wish that Europe would get a move on. On present form, the Cannes summit, and possibly the entire single currency project, is doomed to failure.

Sunday Indo Business

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