Eurozone and IMF: Tortoise with a Hare in the Hat?
The euro currency crisis is sliding from bad to worse. The gloom is likely to deepen on Wednesday when Europe’s executive body has its say on the feasibility of issuing special bonds to refinance government debt.
European failure to restore confidence in its economic soundness and solvability will have unpredictable negative consequences for the US and other major countries because all have significant trade and financial relationships with Europe. In particular, their banks may be knee-capped because of being closely intertwined with European banks exposed to the bad government debt. The hits to economic growth and jobs may take years to overcome.
Some experts have begun predicting an “everyone but Germany” scenario suggesting that France, Belgium, Finland and Holland might soon join Italy, Spain, Portugal, Greece and Ireland in the sick room.
Estonia, Slovenia and Slovakia would follow, being too small to bolster the Eurozone, leaving Germany in splendid grandeur. On its own, Germany would succumb to the contagion because most of its business, trade and banking relationships are within the EU.
The European Commission, which is the European Union’s and the Eurozone’s executive, is expected to confirm some of the fears of pessimists. In an urgent report, it is likely to note that issuing bonds to cover government debt violates the Eurozone’s founding treaties and would require negotiated changes impossible to accomplish quickly. However, it will also suggest how to set up the bonds and make them work.
The confusion in Europe is spectacular. A stability fund containing a minimum €I trillion (about $1.3 trillion) is needed almost immediately. The fund already exists on paper but setting it up is proving to be a herculean task because of legal labyrinths of European treaties and regulations. Several reliable experts think even this is too little. They would like to see an over €3 trillion pool available in one way or another through leveraging. Germany, which would end up paying the most, is dragging its feet slowly.
Greece, the sickest Eurozone member, needs about €8 billion within four weeks to meet debt service payments to avoid declaring default. The money for its rescue has been approved by other members but handing over even this small sum might be illegal, or at least of dubious legality. So it has not been handed over. One way of setting aside the legal issues was to get all Greek politicians to make written pledges to implement severe austerity for years. A leader has flatly refused saying that Germany is not the boss of Greece.
The European Central Bank has already broken some of the founding treaties’ cardinal rules for Greece using convoluted methods to all-but-guarantee Greek debt. However, widening the borderline illicit practices to so many more countries would make a mockery of the treaties and agreements underpinning the euro currency and monetary union.
After months of tough negotiations, quarrels and equivocation, the soundest idea to emerge was the creation of some kind of bond backed by all Eurozone states to restore trust in the debt of members. This could bring down the cost of borrowing for afflicted governments. Compared with the interest rates Germany offers lenders on its national bonds, France is forced to pay double and Italy, Spain and Greece nearly three times as much.
The magic number is 6 percent. Beyond that, the message is that markets think the government is not economically sound. Above 6.5%, the debt repayment burden becomes unsustainable. Currently, Germany borrows at around 2.5 percent, while France must pay around 5.5 percent despite a triple A rating. Lower rated Italy, Spain and Greece have to pay 6.5 – 7.3 percent.
A couple of rating agencies have already threatened to downgrade French debt from triple A. If that happens, French borrowing costs would go through the roof causing the entire Eurozone edifice to crumble. This is the nightmare that Eurozone leaders and the European Commission are trying to prevent.
Were the Eurozone a single country, even a fractious federation like the US, it could float bonds to underpin the debts of its members with some credibility for lenders. But its members are sovereign states with very diverse legal, fiscal and economic systems papered over by opaque treaties to which each member gives its own interpretation. Getting fiscal uniformity among such independent states is almost impossible at this time. That undercuts the credibility of a Eurobond underwritten by all members even if it is managed by the respected European Central Bank.
But the European tortoise wends its way with ingenious labor. So, ways are under discussion about circumventing the spirit of the treaties while remaining within their letter through collaboration with the International Monetary Fund. Legal beavers are sifting through each line. Events could move very quickly once the dodges are found. The tortoise might yet pull a hare out of its hat.
The Commission will clarify the legal issues on Wednesday. Then the political Sherpas will discover ways around them. Well, that’s the hope if the Eurozone is not to become a Lehman Brothers and sub-prime crisis multiplied times over for the world.