Articles from Europe

October Euro Deal Was 'Confidence Trick That Failed'

By: Antonia van de Velde

CNBC,

18 November, 2011

The three-pronged deal reached by European leaders in October aimed at preventing the euro zone debt crisis from spreading further did no more than “trick” markets into thinking a lasting solution had been found and has in fact made matters worse, Nomura’s Bob Janjuah said on Friday.

The October agreement — under which holders of Greek debt agreed to take a 50 percent loss on their holdings, banks will be forced to increase their reserves and the euro zone’s rescue fund will be beefed up - was “a confidence trick that has failed," the co-head of cross-asset allocation strategy at Nomura said. “And as a result it has made things a lot worse.”

All those European policymakers and sell-side commentators who said on 27-28 October "to great fanfare" that the solution was now finally in place and that it was now "all fixed" seem to have gone extremely quiet, Janjuah noted.

The only solution, in Janjuah’s view, is a “hard”, non-voluntary default in the euro zone.

“With the late October ‘deal’ now in tatters, and with subsequent developments in Italy, in Greece, and in the market pricing of French risk, the future for the euro zone now seems to be all about the ECB and outright monetization,” he said.

Monetization – when the ECB buys sovereign debt from highly-indebted governments with newly-printed euros – is no longer possible for Germany, which is adamant that full political and fiscal integration over the next decade is the only option, Janjuah said.

The European Central Bank's mandate specifically forbids it to monetize debt.

In Janujah's view, nothing substantive will happen over the short term.

“Even if Germany and the ECB somehow agree to unlimited monetization I believe it will do nothing to fix the insolvency and lack of growth in the euro zone. It will just result in a major destruction of the ECB’s balance sheet", he said.

At that point, he believes Germany and its northern partners would walk away.

Janjuah believes any conditional or finite monetization would actually be the worst idea, but probably the most likely compromise if Germany were ever to cede ground on this issue.

“Markets always want short, sharp, simple solutions. This is why the begging bowl is out for ECB unlimited monetization,” Janjuah said.

"But, as in the immortal words of Messrs Jagger and Richards: 'You can’t always get want you want'".

Italy too big to fail? Odds are it's too big to save

Christian Science Monitor,

18 November, 2011

Markets worldwide are on edge. Investors and politicians are holding their breath over the fate of Italy. Surely European nations will rush to its support. It’s too big to fail, right?

The reality is more alarming: As the eurozone’s third-largest economy, Italy is probably too big to save.

To understand why, look at Greece. Despite the combined efforts of the eurozone nations, the European Union, and the International Monetary Fund and €130 billion ($176 billion) in aid – a sum equal to more than half of Greece’s entire economy last year as measured by gross domestic product (GDP) – Greece still faces the indignity of a partial default.

The best guess is that investors will be forced to accept a 50 percent loss on maturing Greek debt.

What would happen if a similar scenario unfolded in Italy? The market is already pricing in a possible default with each passing day as the yield spread between Italian debt and German benchmark bonds touches new euro-era highs. In a word, Europe’s bailout costs would skyrocket.

Italy’s economy is nearly seven times the size of Greece’s. Applying the same emergency funding-to-GDP ratio that was provided to Greece, it is not unrealistic to expect about €1.2 trillion in outside aid would be needed to prevent a disorderly default in Italy.

Europe’s emergency coffers don’t currently have anywhere near that sum. The European Financial Stability Fund (EFSF), after providing urgent bailouts to Ireland and Portugal, currently has about €290 billion in cash on hand. Further payments are already scheduled for Greece that will further deplete the fund.

In late October, European officials said that more cash would be added to the fund and that the account would also be “leveraged up,” effectively raising the balance of the fund to €1 trillion. In other words, the EFSF would borrow money to top-up the fund. Isn’t this how the Eurozone got into trouble in the first place?

Looking even further downfield, the news only gets worse.

In addition to Italy, it appears that France is heading for its own debt showdown. Last week, the impact of falling German bond yields, together with rising French bond yields, resulted in another euro-era record spread between French and German 10-year notes.

The one positive is that with a debt-to-GDP ratio of 82 percent, France’s, debt is considerably less oppressive than Italy’s 119 percent ratio or Greece’s 145 percent. While the rising yield spread is a worry, France should be able to avoid the same fate as Greece so long as it can continue to attract investors without yields rising to the point of making the cost of borrowing overwhelming.

The same cannot be said for Italy, which may have already passed the tipping point