After an extended absence owing to family medical issues, it’s surely appropriate that my first blog for a couple of months once again is on the subject of the continuing European debt crisis, just as the last one in early August was. The decision by Greek Prime Minister George Papandreou on November 1st, 2011 to hold a parliamentary confidence vote and then a national referendum on the bailout package for his country agreed with so much difficulty by European countries last week has led to a major sell-off in markets globally.
The crisis meetings last week in Brussels between European leaders (essentially those of France and Germany) and the European banks which hold most of the debt of the peripheral Euro-zone countries, alias the PIIGS (Portugal, Ireland, Italy, Greece and Spain), resulted in an so-called “voluntary” agreement by the banks to accept a 50% haircut in the value of their Greek debt. They would also have to raise E106 billion in new capital by June 2012, while the E440 billion European Financial Stability Fund (EFSF) would be leveraged to expand to E1 trillion in size, allowing it to continue purchasing Italian and Spanish government bonds, whose 10 year yields were nearing an unsustainable 6%. The proposed Greek referendum has thrown this tentative agreement into jeopardy. With Greece’s total debt totalling E330 billion, a bigger write-off than 50% would cause problems, but the real worry is the contagion in Spanish and Italian bond markets. Spain’s debt is almost double that of Greece at E640 billion and Italy’s almost six times as large at E1.85 trillion. With French banks and institutions owning E110 billion Spanish debt and E300 billion Italian debt, any markdown in these countries’ sovereign debt would wipe out French bank’s equity, and make a serious dent in German Banks own capital, as their combined Spanish and Italian exposure is E250 billion. The willingness of European governments to bail out their banks for a second time in 4 years is the issue, and has already occurred with Belgian bank Dexia, which has essentially been nationalized by the Belgian and French governments after its borrowing costs spiralled in October.
The obvious and only possible solution is to allow peripheral countries such as Greece, Portugal and Ireland, all of which have already received bailouts that have not worked, Greece for E219 billion, Ireland E85 billion and Portugal E79 billion, to leave the Euro-zone and devalue their way to competitiveness. This is what the UK and Italy did in 1992 when they were forced out of the Euro`s predecessor currency union, the European Exchange Rate Mechanism (ERM), and both countries boomed subsequently, as imports fell, exports expanded and they became more attractive and cheaper destinations to visit. because of the indecision and political posturing of the European elites, the likelihood now is that Spain and Italy will be forced to leave the Euro-Zone as well, leaving a core group surrounding Germany, including the Netherlands, Austria, Belgium, Luxembourg and France, effectively resurrecting the Deutschmark bloc which made the EEC successful from when it was established in the 1950s up to the 1980s. the attempt to introduce political union via a monetary union was always doomed to failure as long as there was no fiscal union. Different countries with different economies and cultures cannot all have one currency and interest rate unless they are willing to surrender their political autonomy. By calling a referendum, Mr Papandreou has given that decision back to the voters. The sharp fall in markets indicates that investors guess what the answer will be in January, and probably will not have to wait until then to see some radical changes in the structure and membership of the Euro-zone.