Eurozone Unity Fractures As Optimism Wanes

 It is interesting reading reports of the negotiations between France, Germany and the other Eurozone countries as they wrestle with the debts of various member states.  The only way the eurozone could be called a single political entity would be if they issued joint debt instruments, for which they all accepted liability as one.  But this is not happening.

The next stage of accepting responsibility for all the debts of their members would be if the countries of the eurozone underwrote all the debts, and guaranteed the exposures of bond holders.  This would ensure confidence was maintained, at least, and would be the next best thing to a genuine amalgamation of the finances of all the eurozone’s countries.  This was the intention of the shock and awe bail-out, as if saying ”no matter how big the debts are, we are bigger.”  That too is proving to be beyond the reach of the eurozone.  The debts are simply too big, and the amount being raised to pay them not nearly enough.  There is now fatigue setting in, and a more honest approach is being taken.  The creditworthy countries simply don’t want to carry the load any more.

As Germany finds herself as the country most able to raise the capital required to maintain such guarantees, it is not surprising that it is becoming politically impossible to do so.  But still no one wants to pull the plug on the Euro.  The humiliation will be too great to bear for the politicians who created it and supported it.  They want to continue with the pretence that somehow the situation will come right.

This extract from an FT article gives the story of the eurozone meeting in Brussels on October 28th 2010 –

Mrs Merkel insisted that bond holders have to carry some of the risk of default in future.  

This is tantamount to admitting that will be defaults, and it has had the effect of sending bond rates shooting up, and that in turn has brought the crisis back into the markets and the media, initially focused on Ireland.

At the Brussels summit dinner of October 28, Mr Trichet warned Ms Merkel bluntly that her insistence on more pain for private investors in future eurozone bail-outs would simply send up short-term borrowing costs, deepening the crisis. That is exactly what happened.

The ECB knew more than any other institution just how dire it had become for Irish banks. It had lent them €40bn in the latest three months alone. Such dependency was clearly not sustainable, the ECB believed. 

They don’t have enough money, in short.

Temporary liquidity was beginning to look like long-term funding at heavily subsidised rates. The Frankfurt-based 16-country central bank was also worried that its support had reduced the incentives for politicians to take corrective action. Dublin was assuming unlimited ECB liquidity could continue indefinitely.

That’s what they were promised.

The ECB could find its monetary policy being determined by Ireland rather than, as expected next month, taking the next steps to unwind the exceptional measures it had put in place after the collapse of Lehman Brothers in September 2008.

But Mr Trichet was also increasingly concerned that the Germans’ push to lean on private investors in a new bail-out system was going to scare the bond market. The day before the summit he called José Manuel Barroso, Commission president, to argue his case. Mr Barroso agreed: this really was not the time to start a debate on the shape of a future bailout – and particularly on the extent to which bondholders would have to share the burden with taxpayers.
As leaders gathered, there seemed to be growing resistance to Ms Merkel’s plans – especially among German allies seething at how she had behaved in Deauville. Fredrik Reinfeldt, the prime minister of Sweden, put it bluntly: “To solve Germany’s problem, we shouldn’t create problems for everyone else.”

This next bit is the interesting part.  The eurozone members simply didn’t realise how big the problem is.  Once they did, they realised that the bail-out strategy isn’t going to work for long anyway.

But once the summit began, opposition began to fold. No president or prime minister spoke up against Ms Merkel, who was pushing the bail-out measures with her characteristic grasp of policy minutiae, according to people who were in the room. It was left to Mr Trichet to defend his position, with only Mr Barroso on his side. “I have the impression that people don’t really realise what the reality of the situation is,” Mr Trichet is understood to have said.

Trichet prefers not to contemplate the loss of the Euro, but it’s not his problem where the bail-out money comes from.  And that is the crux.  Once the national leaders realise how much they will be required to pay, they don’t want to do it.  In short the Euro is not worth everything they have as there are other demands on their cash.

Mr Sarkozy could stand no more. He cut off his fellow Frenchman (Trichet) and issued a stinging rebuke: ”heads of state were accountable to their people, ” he said – ”central bank presidents only to a board of governors”. With Mr Sarkozy’s backing, Ms Merkel won the day. Treaty change would come. But when the markets opened the following week, it was Mr Trichet who was proved right.

After all his pro-Euro rhetoric in the past, it’s amazing that Sarkozy can with a shrug of his shoulders dismiss all thoughts of preserving the Euro, as that is going to impinge on accountability to each of their nations.  It’s as if this was the moment when hope was given up, and reality was faced for the first time. 

whole article

That is a fascinating article, showing the stages being gone through by the leaders of the eurozone.  They wanted to make sacrifices to help their common currency with ”shock and awe” in April, but now it is finally dawning on them how big an undertaking that actually is, they realise that the amounts required are simply too great to be attainable.

They will patch up Ireland as quickly as they can, but markets will not forget what has happened.  The idea of all bondholders having an effective guarantee of no loss has gone.  Eurozone unity is fracturing.  The individual countries are re-emerging.  Eurozone defaults are now inevitable.  The period of Euro-optimism which began in the early 1990s and swept across the continent is now officially over, leaving fear for what will come next, as all that is left in their minds.

John Redwood – 

The Tap Blog is a collective of like-minded researchers and writers who’ve joined forces to distribute information and voice opinions avoided by the world’s media.

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