2013-09-03 By Harald Malmgren
As most of Europe went on its customary August holiday, the Eurozone’s strains temporarily disappeared from consideration.
In late August, complacency was abruptly shocked by top-level German politicians’ admissions that more money would soon be needed for Greece.
Chancellor Merkel went so far as to say that Greece should never have been admitted to the Eurozone – implicitly hinting that Greece might be “permitted” or encouraged to exit. The return of possible Eurozone “exit” did not roil the US financial market, but it did inject fear among Eurozone banks and in trading of Euro sovereigns. Yields began to climb once again.
The 22 September national elections in Germany could prove to be an historic turning point in the future of the Euro and the Eurozone.
It is unlikely, but possible, that Germany would relent from its continuing objections to intra-EU financial transfers and allow some form of common Eurozone or EU assistance to troubled member governments or even their troubled banks.
This is unlikely. After the German elections, there will be a period of coalition transition and allocation of cabinet responsibilities in Berlin. Soon after, there will be a new finding by the German Constitutional Court on the possibility or legality of new ECB financing mechanisms under the present German Constitution.
The most likely Court determination will be further restrictions on approval of financial transfers among Eurozone and/or EU governments, and admonition that new initiatives to provide relief to troubled Euro member economies and banks require negotiation of changes in the EU treaties.
Even if all of these impediments could be overcome, a German taxpayer revolt would likely follow a new decision to provide German taxpayer money to the neighbors.
If the German government calls for renegotiation of EU treaties, several other governments will readily agree – but with different motivations.
Germany would want other Euro nations to yield sovereignty over their fiscal policies. The financially stressed, recession plagued members (including not only Portugal, Spain, Italy, Greece, but also France) would seek joint issuance of debt but preservation of national fiscal and bank regulation autonomy.
The UK government would likely be eager to reopen many provisions of the EU treaties to restore national and local sovereignty over numerous areas of judicial, police, and local government autonomy (sometimes referred to as “the Third Pillar”).
Renegotiation would also open up previous arrangements to support European Union agricultural interests, as some members would seek to end fiscal transfers from their own budgets to farmers in other member nations.
Opening up the Common Agricultural Policy (CAP) would reopen the delicate political balance between rural areas and cities in several countries, including both France and Germany.
German Finance Minister Schauble has on several occasions declared that new forms of aid to troubled Euro members would require treaty renegotiation. This probably reflected his expectation of what the German Constitutional Court would conclude. European and world markets have not yet awakened to the reality that treaty renegotiation would take several years, not several months, because of the large national political differences – especially during prolonged recession.
In other words, soon after the German elections markets will become cognizant that no new large-scale financial relief will be made available to Euro member governments or their banks.
Currently possible might be another round of LTRO lending by the ECB in exchange for collateral held by member central banks or their private member banks. The problem with that is that almost all collateral in Europe with any remaining value has already been pledged.
Will the ECB continue to lower its standards for “acceptable collateral”?
How far can the ECB go in taking on high-risk collateral?
How big would “haircuts” become?
Would the ECB evolve into a Chinese type of debt creation machine without being supported by material economic assets?
In other words, with the coming of autumn the Eurozone financial crisis is likely to explode once again.
This German election will likely provide an historic test for the future of the “European Project.”
Because of the great size and substantial leverage of Eurozone banks, a financial crisis inside the Eurozone will have contagion consequences elsewhere in the world. The interconnectedness of financial institutions, including banks, insurers, and other so-called shadow banks will likely become evident once again, effects transmitted through credit default swaps (CDS), various derivatives, and unrealizable margin calls.
In response, European leaders will likely embark on another series of Summits, hoping to maintain an illusion of progress in resolution of re-emergent financial strains.
If no collective action is possible to rescue the banks, the formula for stabilization of the banking sector will likely be the Cyprus model: “bail ins” not “bail outs.” Shareholders, bondholders, and both public and private depositors will be required to participate. In some areas, like Spain, many depositors in the past were persuaded to convert their deposits to higher-yielding securities like preferred shares. In those cases they would not simply suffer a “haircut” on deposits but forfeit all of their savings in the form of higher yielding securities.
Viewed from a North American or Asian perspective, “bail ins” do not look as challenging as they do to Europeans.
In North America, businesses and local governments have a variety of alternatives to finance their ongoing activities: not only banks, but also availability of alternative sources of capital. The financial markets are made up of a wide variety of potential investors and lenders, both public and private. In the Eurozone, the financial market is primarily constituted by the banks.
Troubles for the banks mean not only trouble for private businesses and households, but also financing trouble for local and national governments.
For example, it may be recalled that the public rescues of Europe’s Dexia Bank not only included support from the governments of France, Belgium and Luxembourg, but also from the US, because of the large role of Dexia in the financing of local governments in Northwestern Europe – and inside the US.
Photo taken from the following article and hereby credited:
For our look at the broader considerations of the Euro Crisis see the following flip book version of our Strategic Inflections Report: