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BY PERSELLA IOANNIDES
Despite a welcome intervention by global central banks on 24/11, the Eurozone remains on a precipice as Brussels continues to hesitate in the face of German resistance. However, continued inaction is no longer viable; it is hoped that the coherent effort of the central banks will spur Europe to follow suit at the upcoming summit on the 9th of December to resolve the crisis.
Contagion spreads from Eurozone periphery to the core
A potential watershed moment was the disappointing German bund auction on 24/11, with only 3.6 of 6€bn 10 yr bunds sold. It is possible that the yields on offer were simply too low to tempt investors (at 1.98%), but it arguably demonstrated the crisis is no longer confined to the periphery.
New governments, crisis persists
Merkel had hoped that new, respectable technocrat leaders for Greece and Italy would improve market perception, but investors continued to shun the respective bonds, pushing Italian 10 yr yields to above 7.8%. Spain’s newly elected government, committed to reforms and austerity, also failed to cap Spain’s 10 yr yields.
Looming recession
The continuing malaise tightens interbank short term lending while, additionally, firms are pulling deposits from peripheral banks. The new capital ratio requirement imposed on European banks is also adding pressure to strengthen balance sheets through asset sell offs. As a result, the credit crunch, fiscal austerity and a collapse in business and consumer confidence is threatening the Eurozone with a deep recession with a fall in output of about 2%.
Discussed solutions
• Eurobonds – one unilateral bond for the Eurozone guaranteed by all Eurozone governments (would require EU treaty changes), carrying a fixed financing rate. This would share the debt burden across all member states. Germany and other northern countries oppose this idea as they can no longer enjoy low financing rates and will carry on more debt.
• ECB as lender of last resort – the ECB will be ready to lend money to a bank if market financing is unavailable (e.g. UK government with Northern Rock). However, the President of the Bundesbank, amongst others, is strictly against this, as the ECB does not have the mandate to do this and it could compromise its independence.
• Fiscal Pact – Germany and France are in the process of negotiating a potentially groundbreaking fiscal pact that would make budget discipline legally binding and enforceable by European authorities. Officials long regarded this policy as economically necessary but politically untenable. As such, it is hoped that the ECB will take more forceful action towards the crisis given this legally binding, debt controlling measure, especially as it is supported by Germany.
Other opinions
• Buffett – the debt crisis has shown a ‘major flaw’ in the Eurozone system and it will take more than words to fix it. Europe will either have to integrate more closely or come to another arrangement.
• Soros – action should be taken quickly to save Europe and leaders must fundamentally change their approach to succeed. The EFSF should be used as a guarantor to banks which would in turn be able to buy high yielding government debt of troubled Eurozone members. This would be a ‘trick’ to circumvent the flaw that Europe has a single currency without a lender of last resort.
Currently, a breakup of any form of the euro could have detrimental effects on the global economic recovery. The severity of the current crisis has been underestimated, as have the political complexities. Political leaders, in an attempt to force peripheral countries to adhere to fiscal austerity measures, capped the bailout out solutions to levels that are neither economically viable nor acceptable by market sentiment. The situation that started in Greece two years ago is now threatening the breakup of the Eurozone.
Targeted pursuits have been accomplished, with a switch of inefficient governments to technocratic administrations, tasked with implementing corrective measures.
Mere fiscal austerity measures without accommodative support will not suffice. We are in need of a bold move.NOW.
Persella Ioannides heads MeritKapital. She has an MBA from Columbia University and previously worked for Morgan Stanley’s institutional equity derivatives desk. MeritKapital Ltd is a CySEC licensed investment firm. www.meritkapital.com
