AXA: Eurozone Breakup a Real Possibility

Before European readers get upset about the discussion of continued concerns about the eurozone, some of its eager defenders appear to subscribe to an extreme form of indeterminacy.

If you recall the famed Schrodinger’s cat, the indeterminacy of the position of an electron is made (somewhat) more comprehensible by a thought experiment in which a cat is in a box with a vial of poison gas which will be released when radioactive decay reaches a certain point. Is the cat alive or dead? Perversely, the cat is neither until he is observed; he is in an indeterminate state. But once the lid is opened, he is either dead or not dead, the indeterminacy resolves into one quantum state or the other.

Now of course, we don’t know if the eurozone will survive this test. Even though member nations are in theory committed to its success, it requires the surrender of a considerable amount of national sovereignity to create enough of a eurozone fiscal architecture to make it viable in the long term. Completion of these arrangements is one obstacle to success; a additional self-imposed hurdle is the severity of the austerity programs required of member nations (and the refusal to employ internal rebalancing, aka, promoting more consumption in Germany, to aid in the increase in savings in periphery countries). But point that out, and some readers here react as if you are telling them the cat might be dead, when they deem that to be an unacceptable line of thinking. They would rather live with the indeterminacy of hope than consider that the eurozone will either prevail or be restructured in a serious way, and they seem unwilling to look at the conditions and odds associated with each end state.

While concern about Greece persists, Spain is now looking far more wobbly. It now has virtually no access to international capital markets, and its banks’ borrowings from the ECB increased 26.5% since May. Bond prices fell sharply as government officials ‘fessed up to the difficulties domestic firms were having in raising funds.

This development is also stark confirmation of what this blog (most notably, Rob Parenteau and Marshall Auerback) have warned: that fiscal austerity at the same time when the private sector is deleveraging is a one-way path to economic contraction and deflation, unless you can severely depreciate your currency so that rising exports provide some ballast. As the Financial Times noted:

However, a government austerity drive, which economists say will delay economic recovery, continues to undermine confidence in the country’s ability to refinance maturing bonds.

This has pushed up the costs of sovereign and private sector debt issuance and deprived weaker banks and companies of short and medium-term liquidity and financing.

Yves here. Note that this shows, vividly, that the policy that the ECB has insisted, vehemently, at the G20 meeting would work, that implementing austerity programs would increase confidence and support growth, is being repudiated by the markets. Worse, a UPI story by Martin Walker (hat tip Marshall Auerback) demonstrates not only how firm Trichet’s commitment to this misguided program is, but also how it is creating a rift with the US:

Well-placed European sources say last weekend’s meeting of Group of 20 finance ministers saw a strident row between U.S. Treasury Secretary Timothy Geithner and Jean-Claude Trichet, head of the European Central Bank.

It began when Geithner made his appeal for the Europeans to go easy on their austerity program….emergent economies were doing well and the United States was recovering; but both could be derailed if the Europeans slammed on the collective brakes. (One source says that Geithner went on to say that massive European spending cuts would be like adding the deflationary crash of 1931 to the stock market collapse of 1929.)

Trichet, his face red and his voice raised in anger, turned on Geithner. How dare the Americans speak this way, when the whole crisis was the fault of the Americans? It was the U.S. sub-prime mortgage crisis and the bonus-crazed culture of Wall Street that had got the world into this mess. But the Americans were taking no responsibility and very little of the burden….

Trichet made a point of stressing that European spending cuts would actually help the global economy by restoring market confidence, shaken by Greece’s sovereign debt problem and concerns about other members of the euro currency…

Perhaps Geithner was too polite to turn the tables on Trichet and point out that it was the eurozone and its policies that had let Greece drift steadily into such trouble…had also allowed France and Germany to flout the core rule that budget deficits shouldn’t go to more than 3 percent of gross domestic product. The eurozone, by trying to marry a single currency with more than a dozen separate national economic policies, had brought this problem upon itself. Many eminent economists, including the 1989 report for EU Commission President Jacques Delors, had warned specifically that this would be a critical problem.

Yves here. While the blame game makes for good theater, the central point is crucial: the eurozone is adopting disastrous policies to restore market confidence, and appears determined to adhere to them in the face of outright rejection.

As Ambrose Evans-Pritchard reports in the Telegraph (hat tip reader Swedish Lex), the French financial group AXA believes the €750 billion rescue package is a mere band-aid:

Ms Zemek [head of global fixed income at AXA] said the rescue had bought a “maximum” of 18 months respite before deeper structural damage hits home, with a “probable” default by Greece setting off a chain reaction across Southern Europe. “It would be the end of the euro as we know it. The long-term implications are at best a split in the eurozone, at worst the destruction of the euro. It is not going to end happily however you slice it,” she said…

Axa said there was “no chance” that the EU’s €750bn “shock and awe” shield will succeed since it treats Club Med’s debt trap as a short-term liquidity crisis…

A number of ex-IMF officials have said the policy is doomed to failure since there is no devaluation or debt relief to offset the ferocious fiscal squeeze, and may endanger the credibility of the Fund itself. The IMF had floated the idea of a debt restructuring but this was blocked by the Brussels.

The strategy assumes that voters in Greece and other Club Med democracies will endure years of pain for the sake of foreign creditors. “It’s a pipedream,” said Ms Zemek…

Contagion from a Greek default would be harder to control than fallout from the Lehman collapse. “This has huge implications for banks. These bonds didn’t just disappear; they went somewhere, allegedly into French money markets and insurance companies, or on to French balance sheets,” she said….

Axa said the America’s currency union is successful because Washington has over-riding legal powers over the 50 states. “It is a precondition for the system to work but it doesn’t exist in Europe and the bond markets are starting to figure this out. We are looking at a noble experiment on the brink of failure,” said Ms Zemek.

Yves here. The problem now is the sovereign debt sits at banks that in many cases have positive net worth thanks only to charitable accounting. The eurozone members cannot credibly backstop the debt. Writedowns and losses are inevitable. It would be better to do it in an orderly fashion, via restructuring, but indeterminacy, aka extend and pretend, is the order of the day.

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  1. attempter

    I agree that Geithner’s not exactly the right man for the message, but it’s neverthless true that it was Germany and France who were the predatory lenders who facilitated all the alleged Club med binging, and were also happily flouting the 3% limit themselves. (Once again we see how no “rule” or “law” will ever be adhered to except where convenient, so long as the rackets exist.)

    Since I’m sometimes criticized for my criticism of globalization arch-cadre Paul Krugman, I’ll make a point of crediting him for making the excellent point that Ireland’s austerity immolation has done nothing for the market’s “confidence” in it.

    So we have proof that the whole market-confidence justification for austerity is a Big Lie, and that this robbery of the people’s legal property is being undertaken for its own sake, because these corporate-government nexuses are kleptocracies.

    Even though member nations are in theory committed to its success, it requires the surrender of a considerable amount of national sovereignity to create enough of a eurozone fiscal architecture to make it viable in the long term.

    The trilemma is another scam. The logic of globalization leads to one possible conclusion: “free” flows only where beneficial to the most powerful gangs, national sovereignty maintained on an optional basis (e.g. the US government fetishizes its “sovereignty” where it comes to something like the ICC, but happily relinquishes it with NAFTA or BP in the Gulf) only by the most powerful national gangs, democracy destroyed everywhere.

    1. Skippy

      Awwww…neoconscam0crats (tomorrow’s consumption today!) singing kumbaya next to the free markets campfire, with never a thought of the hungry bear on one side and the pack of wolfs on the other, under the cover of darkness (future).

      Skippy…pass me a synthetic derivative marshmallow please.

  2. wojciech

    I see premature self-satisfaction in this post. Stating fiscal austerity bad outcomes when it was merely announced not implemented and binding that with current problems is far overstrech of logic. I’m not saying that the predicted outcome will not manifest itself as author thinks, but it still remains to be seen. In the meantime I would like to point out that currently global economy still drives on last year stimulus. I want just remind everyone that those so hated by some German budget cuts starts in 2011 not now…

  3. purple

    It’s difficult to take the whole EU project seriously when Belgium itself wants to split up. And I recall a recent trip in which a Czech was fulminating about ‘primitive’ Slovaks. Too much of Europe seems quite content with tribalism.

    1. NOTaREALmerican

      True. But, imagine attempting to form a “more perfect union” of these 50 states today. Humans naturally distrust each other. Unions are generally formed when there’s an alignment of the planets allowing a union between the smart amoral scumbags from various tribes. The dumbass peasants will generally “agree” if the priest class can create a good BS story for their tiny brains.

  4. A, Gouveia

    Yves, you still haven’t explained how we would go about making sure germans buy exclusively PIIGS products, and not more chinese/american stuff…

    It would be more viable to just GIVE the said countries more money.

    1. Adam

      It’s not really about German’s buying more it’s about increasing German workers wages. As wages go up so should consumptions – but more importantly the disparity or the imbalance within the Euro countries would be corrected that way. “Giving” Greece (or any of the PIIGS) money would help alleviate the current problem (giving, here, being the same as forgiving debts) but its only a temporary fix as the problems will re-occur without fixing the imbalance.

      The unfortunate problem currently is that nobody wants to “give” anything and Germany has no interest in fixing the imbalance by increasing its wages. It wants Greece and all the PIIGS to rebalance by deflating their economies. However, that will fail because anyone espousing that solution is ignoring all the debt. If you deflate wages in the PIIGS then you only guarantee mass default (whether it be sovereign or private or both) and another banking crisis.

      1. NOTaREALmerican

        And, of course, who wants to “give” anybody anything? If I can con somebody into giving me something, that means I’ve run a successful scam on them; which leads to the “fool me once” joke.

        1. Bob Visser

          Correct! The calvinistic Germanic north, representing the “austerity” religion, has finally discovered that it was taken for a ride, financing the Catholic “Dolce far Niente” religion of the Latin south. These cultures clash and will probably go their separate ways. Greece does not belong and will be more at home in a Mid-East set-up.
          Ms Merkel will return to her roots in Eastern Europe, feeling more at home with a reemerging Russia, than meeting cheating NY-bankers of an empire in decline. She also speaks probably better Russian than English. She then will control N-Europe, an old German dream, and Sarkozy will be allowed to lord it over his Med-Empire. BV

    2. MIchaelC

      Rather than give them money as you suggest, give them (PIIGS Govts) rebates on the inflated assests sold to them by Ger/France (begin by renegotiating debt used for military purchases from Ger/France).

      The analogy that the German and French bond investors were to the PIIGS what the synthetic CDO ivestors are to US subprime borrowers leads to the result that bondholders need to take a haircut, else the taxpayer gets stuck with the haircut. That may hae happened in the US (taxpayer bailout of subprime lenders), but I’m pretty sure a similar taxpayer solution for Euro sovereigns is a much harder sell to European citizens.

  5. Gerald Muller

    What some call “austerity” is really a small decrease in the usual profligate spending of the European states.
    It seems to me that if the “markets” do not condone reducing state spending, what the mlarkets would like is more spending, more borrowing leading to default of the weakest and collapse of said “markets”.
    I am wondering whether “markets” are not a bit suicidal.

    1. michel

      Gerald M

      Spot on. What Yves and Parenteau cannot explain is why they think continuing waste in public sector civil servants whose main activity is to waste money and prevent growth, will actually deliver growth. Its manifestly absurd.

      It matters where the money is spent. We might just as well burn it as carry on as we are.

  6. Dan Duncan

    The ubiquitous use of the word “austerity” is a crock.

    What exactly is the “severe austerity” being imposed upon Spain?

    Far as I can tell it’s 5% reduction in PUBLIC-ONLY sector wages in 2010 (6months left) and a freeze in 2011. This, on people who would have forked over approx 40% of that to the government coffers anyways.

    There’s also the removal of a 2500 Euro “Baby Cheque” which was not a fixture, as it was only established 2 years ago.

    The “severe austerity package”–literally–appears to be about .01% of Spain’s economy. .01%! [Total package is approx $18 billion.]

    The blanket, reflexive use of “austerity” isn’t just being lazy: It’s flat-out dishonest.

    Speaking of diluted terms…I’ll use a pet term of the Left to describe this phenomenon…just so you’re comfortable with what I’m saying:

    The use of “austerity” is downright “Orwellian”. It’s a classic example of what he called “Newsspeak”:

    Use a particular word over and over and you remove all shades of meaning. This, of course, removes any thinking and leads to thought control.

  7. marc fleury

    hmmm I like the schrodinger analogy since it does apply to accounting. I have written a more indepth analysis in the context of naked CDS (aka synthetic CDO coverage) here:

    The point is that mark to market accounting is a forced observation of the cat. Level 3 assets are not supposed to be continuously observed and unwound in the event the current market value says insolvency. There are fluctuations in market prices over time and L3 assets are just that: long dated securities that should withstand fluctuations until realized of observed AT MATURITY.

    I also find myself at odds with the whole “liquidity/insolvency” thing. A liquidity crisis will arise in the event of naked CDS on defaults for example and the authorities were absolutely RIGHT to treat the liquidity symptoms FIRST. A good liquidity crisis will trigger insolvency.

    The problem with the EU of course is that Maastrich prevents the ECB from buying member state bonds, in theory. So a pure QE solution is, again in theory, not feasible. This is a defacto gold-standard equivalent for the EU.
    In practice of course, Trichet (ah! what a name, it means to cheat in french) has jumped all barriers and printed money to buy debt, or at least promised to do so… this liquidity has not yet hit the EU.

    All they are doing is buying themselves time and god knows where all this will be in 5 years… as covered in this blog previously I do see the effects of debt deflation in spain (where I reside) and it promises to be nasty. But don’t count your chicks until all the eggs have hatched or something like that.

  8. charles

    Despite the funding problems, the placing of an ‘umbrella’over Greece ( which most analysts in Europe
    see as having to face a restructuring of its debt )
    and then the secund ‘umbrella'( I remember Willem Buiter’s remark that it is too small and should have been double ) I don’t think there are too many worries about the ‘blow-out’ of the Euro-zone, but rather a higher probability of a second banking crisis looming ( the B.I.S published yesterday its quarterly report and it is not pretty BIS: ) and the current quarreling over the publication of the Euro-zone’s banks’stress-tests, our own Elephant in the room, and the cover-up foreseen by some experts such as Daniel Gros

  9. Ignim Brites

    In the US all the states are being forced to adopt austerity under the rubric that they are constitutionally required to have a balanced budget. In fact there is no federal constitutional requirement for this. The journalistic elite and even the blogosphere doesn’t want to challenge the consensus because they are afraid that if states run serious deficits it will eventually lead to the dissolution of the union. But in the end the inflation of the past fifty years is going to accomplish that anyway. It’s bye bye american pie. CA will be the first to go and maybe as early as the after the next election. Jerry Brown is just enough of an independent spirit to lead it.

    1. Hillary

      In MN (and I believe most states), it’s a requirement in the state constitution. T-Paw’s solution is to “borrow” from future K-12 spending without a plan to pay it back.

    2. NOTaREALmerican

      A liberal (socialist progressive whatever) could never propose “breaking-up” the union. Socialists and fascists political power comes from size, not accountability.

      All human systems get bigger, period (until they collapse).

  10. George

    While I am in aggreement with the main point made in this post, I think the main issue at hand is completely missed. The smoldering then flaring then smoldering Euro zone crisis has nothing to do with any specific financial metrics – though, granted, Greece and the rest of the PIIGS national accounting is the “spark” that sets the crisis off.

    Euro plutocrats have the right to be perplexed, there is no question that Europe has the collective might such that Greece and even Spain should be contained as, say, Califormia duress is manageable in the USA. On paper the collective clout of Europe adds up to be the equivalency to the USA. So why hasnt the market acknowledged that fact and driven on?

    The problem is that Europe, at its heart, is a coup by the zones plutocrats who realized a good gig when they saw one. They could effectively band together and “run” Europe without any elections or popular oversight or messy things like accountability. The original reason why they should have this role, security of Europe against German habitual agression and rising Soviet pressures, were serious enough to let lapse certain key ideas like a “constitution” or an electorate.

    But now those reasons are gone, at least for this century neither Germany nor Russia will be a problem. The USA is a concern but only for this plutocrat elite – the common man in Europe realizes that all the USA wants is access to oil and the ability to tramp around Paris and take pictures.

    The current crisis is that there is no constitutional apparatus in Europe.

    There is also no way to write and institutionalize a constitution. There is no judciary. There is no representative body to manage grievance and provide justice. “Subsidiarity” just doesnt cut it.

    There is no ability to raise funds with representation (remember that messy war in 1776?) and there is no popular oversight. There is no hard power to enforce standards and agreements and law – suppose the Greek national police decide to join the picket line, do German policemen come on back into the country and knock heads in Athens? And it is very difficult if not impossible, to make the case for Europe to: Zorba the plumber, Juan the plumber, Seamus the plumber, Hans the plumber and so on….. Europe was a nice ride for the likes of Jean Monnett and other un-elected “leaders” and pundits, but the gig is up.

    Europe does not have a constitution. Europe will not survive until it has one. I see no over all motivation nor desire for a constitution and therefore, Europe doesnt really want Europe.

  11. NOTaREALmerican

    Re: the cat is neither until he is observed

    Does thinking about observing count? Or do I need to open the box?

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