Wolfgang Münchau
Whatever the Europeans try to do to alleviate the crisis, it does not work: A blanket bank rescue, a €440bn special purpose vehicle to provide a protective shield, and one austerity package after another. Bond spreads and credit default swap indices continue to rise, and the money market is once again freezing up.
This has never happened before to European politicians, who in the past were able to get away with a lot less effort. A statement was usually sufficient to placate the markets.
What is going on?
For a start, there is no speculative attack, convenient as such an explanation may be. What has happened is that global investors have realised a deep underling truth about our European sovereign debt crisis – that at its core, it is not a sovereign debt crisis at all – but a highly interconnected banking crisis about to blow up. There is a dynamic at work that the macroeconomic data does not convey – and that the political response to the crisis does not address.
Those inter-connections are even bigger than we had previously thought – but it should not be suprising given the massive current account imbalances in the eurozone. In its latest Quarterly Review, the Bank for International Settlements came out with some shocking figures. German banks have a $200bn exposure to Spain, $175bn to Ireland, and $50bn, respectively, to Greece and Portugal, making a total exposure to the four countries of almost $500bn, more than 20% of German GDP. French banks have an exposure of $250bn to Spain, $80bn to Ireland, $100bn to Greece, and $50bn to Portugal, also almost $500bn in exposures, but more than 25% of French GDP. Total foreign bank exposures are well over $1100bn to Spain and $800bn to Ireland. Add the four countries together, and you are arrive at more than $2 trillion.
Now, I am not saying that there is $2 trillion of bad debt. I have no idea how big the portion of genuinely bad debt is. The problem is that no one else knows it either, and that includes the banks, which are now refusing to lend in the inter-banking market. There are a lot of parallels to the subprime crisis – including the scale, the inter-connectedness, and the information asymmetries. In the presence of such factors, investors start to panic. The reason they are panicking despite the bank guarantees is that the markets no longer trust the government that have issued the guarantee. The spreads go up, thus reinforcing the crisis. A vicious circle is already well underway.
The vicious cycle has now engulfed Spain. The Spanish private sector is now effectively cut off from global capital markets. The ECB is now the lender of first and last resort to the Spanish banks. Spain’s share in ECB lending is already twice its share in the ECB, and rising. The ECB is desperate for the special purpose vehicle to be in place by the summer. But while this would get the ECB off the hook, it does not solve the problem.
I would expect that early bond purchases by the SPV would trigger a generalised attack on southern European bond markets, France probably included. Having ignored sovereign default risk completely, the markets now regard everything as extremely risky that is not Germany. No matter what happens to the eurozone, Germany can always be relied upon to be a safe bet. If the eurozone ever were to split, there is much less certainty about which side of the eurozone’s fault line Italy and France would end up.
But why does the protective shield not suffice? The reason is political. So far, all those guarantees have not cost us a cent. No taxes have been raised, no expenditure has been cut. But this will be different when the SPV pays actual money. I have heard the suggestion that it could in theory buy Spanish bank bonds directly. It would make sense since the banks are guaranteed by their governments in any case. But when this happens, Germany and others will have to account for their permanent contributions in their national budgets. These are not losses you can hide off-balance sheet – though they will probably try. In the end, money will flow – a lot of money. And I am not sure Germany has the stomach to bail everybody out – even if such action were probably in Germany’s long-term interest.
It is not that hard to see a point at which Germans decides not to participate in any future bailouts. Since each bailout requires unanimity, Germany could block any decision. Or if push came to shove, Germany, along with a small number of other countries, could unilaterally withdraw from the eurozone.
What can turns this into a dangerous crisis is not the absolute level of debt, but the intra-eurozone financial flows. These are a mirror-image of the internal economic imbalances. Germany’s massive current account surplus is per definition a surplus of domestic savings over domestic investment, and these savings are channelled towards economies with large current account deficits, like Spain, Portugal, Greece and Ireland.
Germany is now effectively being asked to bail out its customers. That would require a fiscal union, which Germany is not prepared to consider. The reason the crisis is getting worse again is because investors cannot see how this conflagration can be untangled.
http://www.eurointelligence.com/index.php?id=581&tx_ttnews[tt_news]=2826&tx_ttnews[backPid]=901&cHash=a53e046a43
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