Friday, June 22, 2012

The Eurozone's Time Of Decision

Next week, there is a major summit of EU leaders scheduled. They're going to try to hash out some way of dealing with their ongoing fiscal crisis. Italy's Prime Minister Mario Monti was fairly stark about what's at stake.

As I predicted earlier, Spain's bailout without the insistence of major austerity measures and reduced government spending had been the signal for what amounts to a 'gang bang' on German
Chancellor Angela Merkel. Not only does Italy expect a bailout on similar terms, but Portugal and Ireland now want their bail out agreements amended to cut back on mandatory austerity measures. And they now have another important player piling on Merkel - the head of the International Monetary Fund, Christine Lagarde:

IMF managing director Christine Lagarde warned that the euro is under "acute stress" and urged eurozone leaders to channel aid directly to struggling banks rather than via governments. She also called on the European Central Bank (ECB) to cut interest rates.

The stark message from Lagarde, delivered to eurozone finance ministers who were meeting in Luxembourg, will increase pressure to come up with a unified approach to tackle problems including Spain's struggling banks. She urged the 17 eurozone countries to consider jointly issuing debt and helping troubled banks directly. She also suggested relaxing the strict austerity conditions imposed on countries that have received bailouts.

"We are clearly seeing additional tension and acute stress applying to both banks and sovereigns in the euro area," Lagarde said after the meeting. {...}

One of Lagarde's recommendations for Europe was that eurozone leaders should consider issuing bonds or debt "in some form" backed by the governments of all member countries. Berlin opposes the idea because it would put German taxpayers on the hook for foreign debts and increase the country's cost of borrowing.

In addition, Lagarde said it was necessary to break "the negative feedback loop" that occurs when governments take on more debt to bail out their banks, and she called on Europe's two emergency bailout funds to shore up shaky banks directly.

Let's translate what 's going on here, and more importantly, who it's coming from.

This the head of the IMF, a crucial player in the world's financial order and a major potential source of funds for the EU's troubled economies. And what she's telling Angela Merkel and the Germans is that the IMF's support for the eurozone is questionable unless the Germans and other healthier members of the eurozone agree to purchase Greek, Spanish, Italian, Irish and Portuguese debt that the market has already decided are perfectly lousy investments. Moreover, she wants that debt purchased at at artificially lowered interest rates, and she wants the money to go directly to the banks, so the entire eurozone is on the hook for it rather than individual countries.

The idea here is simple. If the Germans bend over for it,the contagion from the affected countries will be spread throughout the entire system. At the same time, the 'purchase' of the debt plus low interest rates will allow the affected countries to chuck any ideas of fiscal austerity and engage in 'growth' - a euphemism for increased government spending.

If Angela Merkel agrees to this, she's likely to become history politically if the current polls are any indication of how the average German feels about this sort of arrangement.

Even if it goes through, it's a recipe for ruin, and I don't see how it can last for long.

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