Europe Holds Back the Fire for Now

By Delusional Economics, who is horrified at the state of economic commentary in Australia and is determined to cleanse the daily flow of vested interests propaganda to produce a balanced counterpoint. Cross posted from MacroBusiness.

Two weeks ago I wrote a post on Professor Sinn and the growing concern from the German central bank about TARGET2 liabilities. The pressure from the German camp is on-going and late last week it appears they had a win of sorts.

The ECB has given the euro zone’s 17 national central banks the power to ban the use of bank bonds underwritten by governments in EU/IMF bailout programmes as collateral to get unlimited ultra-cheap loans, it said on Friday.

The move is a thinly-veiled attempt to soothe the concerns of Germany’s Bundesbank that the ECB has made it too easy for banks to access its funding and exposed the national central banks to too much risk.

“National Central Banks (NCBs) are not obliged to accept as collateral for Eurosystem credit operations eligible bank bonds guaranteed by a Member State under an EU-IMF financial assistance programme,” the ECB said in a statement following its mid-month meeting.

The outcome of this change is unknown at this time, and we aren’t likely to see it in action until there is another flare up in the interbank market stemming from a renewed sovereign crisis, possibly Portugal or Spain. At this point in time, given most large banks have access to the services of any European National Central Bank, I suspect it will be limited. You do, however, have to ask yourself whether Europe really is pushing ahead with political-fiscal integration when it is now openly taking backwards steps on monetary policy integration with these sort of “opt out” clauses.

In other news out of German, after the Netherlands rejected the idea last week, Wolfgang Schauble has shut down a European financial transaction tax:

Finance Minister Wolfgang Schaeuble conceded for the first time on Monday that efforts to get a financial transaction tax implemented in the euro zone were doomed.

“We just can’t get it done,” Schaeuble said in Berlin.

Schaeuble expressed hope that some countries in the European Union would begin implementing an enhanced stamp duty, including derivatives, this year but admitted that this would not be possible in the broader bloc.

That is surely a big blow to the Sarkozy presidential campaign as he spent the new year’s period in a war of worlds with British PM, David Cameron, over the tax. That however isn’t Sarkozy’s only problem at present:

The number of jobless people in France rose for a 10th consecutive month in February to reach its highest level since October 1999, casting a pall over President Nicolas Sarkozy’s re-election prospects.

Figures released on Monday by the Labour Ministry showed that the number of registered job seekers in mainland France rose by 6,200 in February to 2.868 million, up 0.2 percent month on month and 6.2 percent on the year.

Sarkozy, who is trying to catch up with his Socialist rival in the polls ahead of a two-round April-May presidential election, welcomed the figures as showing a slowdown in the rate of increase in unemployment.

As I have mentioned previously a win by Francois Hollande is likely to be financially disruptive because he has already pledged to re-negotiate the terms of the ‘fiscal compact’. It also appears he is forging new Franco-German alliances with political parties outside of Merkel’s CDU which will make a Hollande-Merkel partnership even more difficult if he happens to become the next French President.

Speaking of Merkel’s CDU, they were successful in winning the state election in Saarland over the weekend although their coalition partner, the FDP, got a trouncing while the Pirate party, surprisingly and somewhat amusingly, continues to grow in strength.

Meanwhile, possibly on the back of that win, Angela Merkel appears be positioning Germany for some concessions on European Firewalls:

Germany signalled for the first time on Monday its willingness to increase the resources available for tackling the euro zone debt crisis, a shift that may help protect Spain as its bond yields rise and concerns grow about its public finances.

Euro zone finance ministers will meet in Copenhagen on March 30-31 and are expected to agree on a method of bolstering the crisis firewall by combining some of the resources left in the temporary EFSF bailout fund with the ESM, a 500-billion-euro ($670 billion) facility that comes into force from July.

Until Monday, Germany had sent no clear signal on combining the resources, with officials indicating that it may not be necessary to do so now that financial markets are calmer.

Merkel removed some of those doubts, telling a meeting of her conservative Christian Democrats:

“We say the ESM should remain permanently at the 500 billion euro level, but in order for us to have 500 billion euros in available money, then we can imagine … allowing the programs … to run in parallel,” she said.

As I said yesterday my expectations are that the Germany will agree to top up the existing ESM with the already committed funds from the EFSF bring the total to approximately €700bn, but I am happy to be surprised on the upside. However, given the concerns of the BundesBank I mentioned at the beginning of the post there is likely to be political resistance from inside Germany to extending the country’s exposure.

Although any German concession on the firewall is likely to be seen as positive, really what it signals is the ever-growing awareness that both Portugal and Spain are making their way down Greece’s path. This is particularly worrying given the size of the combined economies but also because the two countries are very tightly coupled and have very similar economic issues.

The Bank of Spain contends that construction debt to banks stands at some EUR400 billion, of which repayment of EUR176 billion is questionable with EUR31.6 billion of those considered non-performing.

Spain’s banks are also exposed to a potential crisis in Portugal. The Bank for International Settlements reports that Spanish banks own EUR65 billion of Portuguese debt. That’s a big problem, given that many analysts now expect Portugal to misstep and, quite possibly, submit to a debt restructuring.

Given that the IMF forecasts a 1.7% contraction for the Spanish economy in 2012; the storm clouds hanging over Spain’s private debt are growing, which would threaten banks with more losses and raise the risk of more bailouts and capital injections from the government.

Spain’s current public sector debt is currently at a modest 66% of GDP. But that’s up from 30% of GDP earlier in the decade and is expected to rise. Austerity stands to push the economy further into recession, which in turn will increase non-performing loans and increase the public sector debt burden. It’s not hard to imagine a transfer from private to public sector debt rapidly blowing out the sovereign debt ratio toward 100% of GDP in the next few years.

Does Spain then become the next Greece?

The firewalls of Europe are not high enough to drown out the din of alarm bells ringing in Madrid. The euro crisis is about to spread and this time delay tactics by the EU will not work.

Over the weekend the Spanish PM, Mariano Rajoy, failed to clinch a crucial provisional election making his coming task even more difficult.

Spain’s ruling Popular Party has won elections in the southern region of Andalucia but may not be able to force the Socialists from power.

Prime Minister Mariano Rajoy’s party secured 50 seats in the 109-seat assembly, three more than the Socialists, in power for 30 years.

The Socialists could stay in power with the support of the United Left.

Mr Rajoy had hoped for outright victory ahead of a budget on Friday which is expected to herald deep spending cuts.

His centre-right Popular Party (PP) won national elections in November and after they had secured control of 11 of Spain’s 17 autonomous regions in May 2011.


The Popular Party’s leader in Andalucia, Javier Arenas, praised the victory as an “historic achievement” although, as the daily El Pais pointed out, the PP’s share of the vote was down 5% on the general election.

He had earlier promised major spending cuts in the region, but said he would leave education, health and social provision untouched.

Andalucia has Spain’s highest jobless rate of 31% and has one of the country’s highest regional debts.

But none of this “risk off” news will get in the way of Mario Draghi, who continues to stick to his line that everything is getting better:

There are signs of stabilization in financial markets and overall economic activity, European Central Bank President Mario Draghi said on Monday, adding that bank lending is also stabilizing.

“Conditions in bank funding markets have improved,” Draghi said in a speech in Berlin.

“For example, euro area banks have already issued about 70 billion euro in senior unsecured debt so far this year, which is well above the amount they issued in the whole second half of 2011.”

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  1. Gerald Muller

    Since obviously, there will not be a United States of Europe, the euro is unsustainable. Why don’t more people sate this squarely? True, undoing the euro would be difficult especially since everything was done to make an unfolding difficult in the first place. But since the only alternative is between killing the euro or killing many European nations, there should be no question that the ECB and all central banks should be working on this 24 hour a day.
    It does not look that way.

    1. Susan the other

      i think it actually does look this way. Europe is going forward but it has a huge mess to clean up. It cannot put too fine a point on all of this because the general public will take it and run, and it will be magnified 1000 fold in political outrage. Understandably. The solutions must not punish the people. Clearly. But the Banks still lead the discussions in their own interests. The ins and outs of all of this – banking v. politics – is impossible to follow. Especially in the EU. But common sense tells us that it will make a hard left turn turn toward human rights.

      1. ambrit

        Dear Sto;
        “common sense tells us…” Sorry to be contrarian here, but the recent history of the world points towards the opposite effect. Anti-sense is the common currency now.
        Also, Europe is distinctly unlike America in its’ history and social political makeup. With a rich and complex mixture as found in Europe, not to mention those ‘border regions’ appended, Diplomacy comes into its’ own. This is the polar opposite of Business. As long as business interests control and shape the political discourse, diplomacy is doomed to powerlessness. So then is Europe doomed.

  2. ambrit

    Did I read that right? Andalucia has an ‘official’ unemployment rate of 31%?! In any other ‘advanced’ nation I can think of, this would be a symptom of outright Depression. If Spain follows Portugal and shows economic contraction over several quarters, wouldn’t that signal the same? No wonder the Eurocrats with any sense want to build a modern day “Firewall” around the contagion zone. Foot dragging on this will have dire consequences, obviously. If Europe goes, how much will Wall Street suffer? (I no longer conflate Wall Street and America. They live in different versions of reality.) Wall Street exposure to European bonds, and perhaps more importantly, CDS’s, is of interest. Therin lies our American Future.

    1. financial matters

      The gauntlet does seem to be settling in on Spain. This may finally put an end to the folly of the World Bank and IMF austerity programs.

      This would seem to force the debt issue to finally be addressed realistically to the detriment of the banking/govt kleptocracy and in favor of populist programs.

      The money needs to be withheld from the 0.1% and used to form social safety nets to allow a foundation for true entrepreneurship.

  3. ajax

    I’m quite a fan of the Bank for International Settlements,
    even though they issue a multitude of reports that aren’t
    easy reading. It provides a counter-point to statements
    by some central bankers which, for some reason, seem to
    eschew “doom and gloom” statements.

  4. drmis

    Re Spain – don’t forget that there is large grey economy going on there where people are officially un-employed and collect benefits but in fact work for cash on the side.

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