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Mrs Merkel is wary of attempts by Brussels to bounce her country into an EU debt union, or 'Transferunion' as it is described luridly by Germany's press. Such moves may breach the German constitution. Charles Dumas at Lombard Street Research said Germany faces an impossible demand. "If the German people go along with plans to prop up the economies of Club Med to save the euro, it means that they will have to pay subsidies for the next decade or two that significantly exceed what they have had to pay for German reunification," he said.
EMU'S POLITICAL LIMITS
Mark Ostwald from Monument Securities said confusion over the EU bail-out fund is a reminder of EMU's political limits. "We have gone nowhere since the show of unity in December. 'Mr Market' is still saying to EU leaders that they must come up with a mechanism to transfer money from the rich core to the periphery. We are no closer to that," he said.
EC POWER GRAB - "New Phase of European Integration"
Jose Barroso, head of the European Commission, called on EU leaders to boost the firepower of the EU's €440bn (£366bn) bail-out fund and beef up its role, allowing it to intervene with pre-emptive bond purchases to help states under threat. "It is important for the markets to know that Eurozone leaders are committed to do whatever is necessary," he said, hoping for action as soon as early February. He also proposed a "new phase of European integration" with far-reaching oversight of the budgets, pensions, labour markets, and trade flows of EU states to prevent a recurrence of the imbalances that led to the EMU debt crisis. Mr Barroso said the fund boost was a "precautionary" move, not directed at any one country. The gambit is risky since it may be taken by investors as a sign that Brussels fears imminent contagion to Spain, deemed too big for the current fund. The response in Paris and Berlin was chilly. "We think the fund is big enough," said Francois Baroin, France's budget minister. German Chancellor Angela Merkel said the bail-out mechanism was "nowhere near exhaustion", adding curtly that she did not wish to debate the matter "any further".
"The persisting housing crisis, the implications of this on the financial condition of banks and, above all, the high public debt and deficit, both at the federal and state levels. The US is in a dilemma. In the medium term, there is no getting around budget consolidation, otherwise the country will be threatened by a debt crisis such as Europe is currently experiencing. However, given the weak recovery so far, the US must do all it can to boost economic growth"
"The (Obama Tax Cut) plan is a complete waste of money. It's going to increase the deficit without doing anything to kick-start the economy. And, unfortunately, I don't see any chance of this fiscal stalemate changing significantly before the presidential elections in 2012. The White House and the Republican majority in Congress block each other's proposals, and there is no such thing as bipartisan crisis management in the US. I'm sure that the public debt of the US will eventually make the markets very nervous in the next few years."
"The condition of the over-indebted states on the periphery of the euro area is similar to that of the US federal states, from California to Illinois. But there are also clear differences: Even if California were to go bankrupt, nobody would think that the US monetary union would collapse because of this. The debt problems that Greece and Ireland are currently experiencing, could, in contrast, actually lead to a collapse of the euro area. What's more, the US can always finance its debt by printing more money. Greece and Ireland are dependent on the European Central Bank, the ECB, to relax its monetary policy against the will of Germany. There is simply more discordance than agreement in the euro area."
"The cost-cutting measures, the ECB's tight monetary policy, the current high value of the euro -- that's all fine for Germany and the heart of the EU. But what's good for Germany is by no measure good for the countries on the periphery of the EU. The economic output of Greece, Ireland and Spain is shrinking, and there is hardly any growth in Portugal and Italy. To get these countries back on track for recovery the ECB should do what the Fed is doing and increase the money in circulation to stimulate growth. Europe needs growth to prevent a disorderly collapse of the euro area. The stringent cost-cutting measures that the EU and the International Monetary Fund are imposing on countries such as Greece and Ireland are, in principle, the right way to get a handle on their debt. However, these measures also strangle an economy. Higher taxes mean people have less money to spend. If the government cuts spending it cannot make investments to stimulate growth. This creates huge difficulties for the governments concerned: If people cannot see the light at the end of the tunnel they will start to withdraw their support for reforms. In the interests of Europe as a whole, Germany should do all it can to bolster growth -- at home and in Europe. Germany should, therefore, postpone its austerity strategy."
"The German growth model will not work in the medium term, not for Germany, nor for Europe. Germany's economy relies too heavily on exports. At the beginning of the financial crisis the German slump was higher than in the US, where the crisis originated. Even if domestic demand is now gathering pace, Germany must do more, such as liberalize the service sector and stimulate consumption. And this would kill two birds with one stone: it would reduce Germany's dependence on exports and cut its trade surplus, which causes other parts of Europe to slide further into the red. I have worked on debt restructuring for a number of years and have not been able to identify any really workable proposals from Germany for helping countries such as Greece and Portugal to emerge from the debt trap. If you don't mind me saying so, the idea of an international insolvency law is absurd, as orderly restructuring of sovereign debt doesn't require a new legal framework.
"What the euro countries decide for 2013 is completely inconsequential. Forget 2013! The important thing is what will happen in the next three months in Portugal, Spain, Italy, and France. I can't fathom how the EU member states can hold a summit entirely preoccupied with what will happen after the present rescue package runs out, without once mentioning what they intend to do now to help Portugal and Spain."
Europe must make more money available to defend its currency and sovereign states under stress. Which tools it uses to do this is of secondary importance. Of course, the EU can continue to rely on the ECB to do its dirty work and buy up the government bonds of distressed states. But it would be better to drive a proactive strategy and increase the bail-out funds, introduce euro bonds, or even set up a European monetary fund. All solutions have one thing in common: the German taxpayers' money will be used to stop the debt crisis in other countries. In Germany's place, I would opt for increasing the bail-out package… The fact alone that everybody knows this increases the risk of a run on Spanish banks. If the rescue package isn't increased soon the ECB will have to buy Spanish government bonds. The German taxpayers will ultimately have to foot the bill for this, too, as the ECB will need more capital. What it comes down to is a deal: If the Germans agree to relax the ECB's monetary policy and provide more money to defend the euro and the weaker states, then they should, in return, get regulations that automatically punish countries flouting budget rules. Overly indebted states would then have to accept a loss of their autonomy in fiscal issues. This would be a hairy deal but could avoid the collapse of the euro area.
SPIEGEL: The euro area's problems and the relaxed monetary policy of the US are causing large inflows of capital into emerging countries. Is this the beginning of the next dangerous bubble?
Roubini: The interest rates in the developed economies are at zero percent, and there are concerns about the stability of their currencies. Emerging countries such as Brazil are consequentially being flooded with cash. And this capital seeks investment options even in places where there aren't any good opportunities. It's difficult for emerging countries to stem this tide of capital. If they let their currency rise in value they loose their competitiveness.
SPIEGEL: The Chinese yuan, in particular, is causing strife. The US is accusing China of keeping its currency artificially low in order to reap the benefits in its export markets. This could lead to a currency war.
Roubini: I wouldn't call it a war, but there is tension. To even out global growth a little better there is no other option than to weaken the dollar and increase the value of the yuan. Nobody would call on China to increase its currency by 20 percent in one go. But the 2 percent that the Chinese have brought themselves to implement in the past few months is not enough. A midpoint -- at around 6 percent per year like in the 2005-2008 period -- would satisfy all sides.
My advice is simple: diversify! Don't buy anything that's overpriced! The global economy is on the right path, but there are risks along the way. Growth in the euro area is still dependent on that of the US. Policy mistakes in China or in emerging countries could strangle growth. On top of that, we have oil price levels which will soon no longer be viable for industry. North Korea and Iran still represent dangerous trouble spots. 2011 is set to be a risky year for investors even if the global economic outlook is improving.
Ireland told everyone that they were not Greece.
Portugal is now telling everyone that it is not Greece or Ireland.
Spain insists that it is not Greece, Ireland or Portugal.
Italy says it is not in the "PIGS".
Belgium insists it was no "B" in "PIGS" or "PIIGS".
Greece had a bloated public sector and an uncompetitive economy sustained by low Euro interest rates.
Ireland suffered from excessive dependence on the financial sector, poor lending, a property bubble and an increasingly generous welfare state.
Portugal has slow growth, anaemic productivity, large budget deficits and poor domestic savings.
Spain has low productivity, high unemployment, an inflexible labour market and a banking system with large exposures to property and European sovereigns.
Italy has low growth, poor productivity and a close association with the other peripheral European economies. Italy has recently started to rein in its budget deficit. The Italian banking system is relatively healthy but exposed to European sovereign debt.
Belgium is really two ethnic groups that share a king and high levels of debt (about Euro 470 billion, 100% of GDP).
Portugal, Ireland, Greece and Belgium are also small, narrowly based economies which increases investor’s risks. The countries have in common, very high and potentially unsustainable debt levels. They also have in common a reliance on foreign investors to purchase their debt.
Contagion is transmitted through different channels. The rising cost of borrowing increasingly makes high levels of debt unsustainable because of the cost of meeting interest payments. Eventually, countries lose access to commercial funding sources, which is what happened to Greece and Ireland. By the end of 2010, the cost of funds for the relevant countries had risen, in some cases to punitive levels.
Greek debt is trading around 12%.
Ireland trades at around 9.50%.
Portugal trades around 6.60%.
Spanish debt now trades at 5.50-6.00%, while
Italy is trading close to 5.00%.
Rising rates result in unrealised losses on investor holdings of the debt. If EU/ IMF support is not available and the debt is restructured or defaults when it falls due, then this loss is realised. This affects the profitability and potentially the solvency of investors or banks depending on the quantum of exposure or size of the losses.
Banks have lent over $2.2 trillion to the PIGS.
French and German banks have lent around $510 billion and $410 billion respectively.
British banks have lent $324 billion to Ireland and Spain.
The problem is compounded by complex cross funding arrangements. Spain, which may need financial support, has $98.3 billion exposure to Portugal as well as a $17.7 billion exposure to Ireland.
The final channel of transmission is less obvious. Where stronger countries move to support the weaker countries, financing the bailouts affects their own credit quality and ability to raise funds. As concerns about the peripheral countries increased, interest rates for Germany and France, which would have to bear the burden of supporting others, rose.
Europe increasingly resembles a group of mountaineers roped together. As the members fall one by one, the survival of the stronger ones is increasingly threatened.
Available options include:
1- greater economic integration of the EU,
2- expansion of existing arrangements or
3- a decision to allow indebted countries to fail.
If the EU does not agree to fiscal union or continuing support, then pressure on Portugal, Spain, Italy and Belgium may reach a tipping point, making default or restructuring the likely end game. Presumably, existing programs, such as those for Greece and Ireland, would be suspended. Governments would announce debt moratoriums, defaulting on at least some debts and forcing write downs. This would be followed by a domino effect of defaulting countries within Europe. The defaults would affect the balance sheets of banks, potentially forcing governments, especially in Germany, France and UK to inject capital and liquidity into their banks to ensure solvency. The richer nations would still have to pay, but for the recapitalisation of their banks rather than foreign countries.
The report perceived three "clusters" of risks:
• The threat of a new economic crisis which could arise from the tension between the increasing power and wealth of emerging economies and the high levels of debt in the west.
• An "illegal economy nexus" involving fragile states, illicit trade, organised crime and corruption. The report said the value of illicit trade was an estimated $1.3tn (£830bn) in 2009.
• The "unsustainable pressures" on resources created by a rising population and growing prosperity, which was expected to increase demand for food, water and energy by 30-50% in the next 20 years.
In addition, the report highlighted five risks to watch:
1- the possibility of "all-out cyber warfare";
2- the additional fiscal pressure from ageing populations;
3- high and volatile commodity prices;
4- a retrenchment from globalisation; and
5- the acquisition of weapons of mass destruction by terrorist groups.
Robert Greenhill, managing director and chief business officer at the World Economic Forum, said: "Twentieth century systems are failing to manage 21st century risks; we need new networked systems to identify and address global risks before they become global crises,"
Daniel Hofmann, Zurich Financial's chief economist, said:
"Current fiscal policies are unsustainable in most industrialized economies. In the absence of far-reaching structural corrections, there will be a high risk of sovereign defaults."