Author : John E. Charalambakis
Date : October 24, 2012
There are two opposing forces that are taking place in the EU. One pushes for greater political and economic integration, the other for greater disintegration. At the same time secession forces are aspired from Spain (Catalonia), Italy (Venice), U.K. (Scotland), and Belgium (last week’s electoral victory of the Flemish nationalists). Resentment is on the rise in the EU against the bureaucracy of Brussels that has been failing to anticipate the fundamentals threats that are building up for more than ten years now, threats that are undermining the very foundation of the EU.
We may need to review one of the most fundamental reasons that brought down the Soviet Union, i.e. that it made the wrong assumptions about human nature. It seems that the EU is on the same trajectory. As for the Nobel Peace prize, I consider it to be the epitome of absurdity. If it were not for NATO, would the EU be capable of keeping the peace? The bottom line of the 21st meeting of the EU leaders last week was: They agreed to come to an agreement in the near future. Let’s review then some fundamental facts:
First, there is a basic difference of opinion between the IMF and the EU institutions (Commission and ECB), regarding Greek finances. The IMF believes that the Greek debt is unsustainable (and I think there are right), while the EU keeps missing the boat, by desiring the kick the can down the road, and being oblivious to basic arithmetic. If the Greek debt is unsustainable, then IMF regulations forbid it from disposing the next tranche of financial aid. In that case, the EU needs to pick up the tab. However, there is no more appetite for greater aid to Greece. At the same time, the IMF may be feeling that is in a limbo given that it is expecting the outcome of the US elections. A Republican victory may become the cornerstone of IMF’s withdrawal from EU financial assistance.
Second, while there was on the table a proposal for a banking union in the EU, the implementation of that proposal has been postponed for sometime (indeterminate at this point) in 2013. As we had pointed out in commentaries in the summer of 2011 (before the crisis erupted in its present feverish phase), EU banks need to refinance close to $4.5 trillion dollars of unsecured bonds that they have circulated. We believed and still hold the same belief that the appetite for such bonds is very little, given the shaky balance sheets of EU banks (unless the ECB buys them, proclaiming again it motto regarding quantitative easing “to infinity and beyond”). France is pushing for the banking union to be implemented ASAP, maybe because it anticipates a financial tsunami. Germany desires to go slow regarding the banking union. The British Prime Minister is threatening with a veto regarding an overreaching EU budget in combination with a banking union, since it may undermine the City’s authority. The IMF in the last couple of weeks came out and said that EU banks need to get rid of $4.5 trillion of toxic assets! My question is: why should the public bail out the banks that caused the crisis in the first place? Didn’t we have enough of this tragedy of the commons?
Third, the projections made – based on the recipe/treatment of austerity – have backfired. Unemployment has risen from 7 to 25% in Greece. Public finances have deteriorated. Debt has skyrocketed to over 160% of GDP. Somehow, the new math of desiring to add through subtractions did not work out well (something expected since they were trying to treat the symptoms rather than the causes of the crisis). Contagion has been spreading. New estimates show that a Greek exit from the Euro zone will be followed by other countries too, and the total cost may exceed €17 trillion! I am still of the opinion that the Euro is too much of an expensive currency for Greece.
Fourth, Germany is hesitant to make significant decisions, given the pending election about a year from now, and hence, the continuous postponements. Moreover, Germany desires to impose a Euro-wide finance commissioner with excessive executive authority who would have veto power over national budgets and whose authority will surpass that of the EU Commission. Germany knows that through the Target2 program (for which we have written a few times in the past), its central bank is in the hook for more than €650 billion, and amount unthinkable for even Germany.
Fifth, while the ECB declares that it stands ready to become the ultimate banking supervisor in the EU, a financial bomb may be hiding in its foundation. Given that the Greek debt is unsustainable, the ECB would need either to roll over the Greek debt that is holding or take a haircut on the portfolio of its Greek bonds, let alone that for the short term it would have to keep accepting Greek short term bills through its ELA (emergency liquidity assistance) program. However, either of these two options seems to be against its bylaws.
Sixth, Greece would need about €18 billion of additional financing, due to a shortfall in revenues, the (expected) extension of its adjustment program, the depression it is in, and the maturing bonds. Hence, it needs either more financing (something difficult) or a new haircut (thus the ECB’s probably involvement, as mentioned above). It seems almost imperative that the recapitalization of Greek banks has to be done through the ESM (permanent EU bailout mechanism) in order to relieve €50 billion of debt. Given the huge amount related to a Greek exit, the question that needs to be answered soon is: Is Germany and the other surplus countries willing to abandon their policies and rescue the rest of the EU?
In closing the review of these fundamental facts, allow me to state that we are not dealing only with a dysfunctional currency but most importantly with an EU that suffers from an identity crisis.