Fiddling in Frankfurt as Europe Burns

10/20/2011 9:30 am EST


Igor Greenwald

Chief Investment Strategist, MLP Profits

The “Big Bazooka” European rescue plan is looking more and more like a costly dud, writes senior editor Igor Greenwald.

In this installment of “A Nightmare Called Europe,” Greece is consumed by protests, strikes, and riots, and the French president misses his daughter’s birth to fruitlessly plead with the German chancellor for more support in an emergency meeting at the Frankfurt opera house.

It was a cruel comedown from Tuesday’s market-moving rumor that Germany and France had agreed to leverage the Eurozone’s €440 billion ($603 billion) rescue fund into a €2 trillion “Big Bazooka” of credit guarantees for the increasingly discredited sovereign borrowers.

That was too good to be true, of course. Within hours, Germany’s finance minister said €1 trillion in bond insurance was all he could countenance. Germany and the European Central Bank have also shot down France’s attempts to turn the rescue fund into a bank with a credit line from the ECB to boost its firepower.

Most tellingly of all, The Wall Street Journal reports this morning that Germany isn’t even willing to let the rescue fund itself insure a portion of its allies’ debt. Instead, the fund would lend money to national governments wishing to dangle such guarantees—further increasing their debt in the process.

Germany, already on the hook for €211 billion in rescue funds, is unwilling to open its pocketbook any further.

Trouble is, even €2 trillion would amount to a costly band-aid for the cancer spreading across the continent. Europe has no way of fixing a half-baked currency union that has condemned the inflexible and over-borrowed economies on its periphery to a deep recession and, ultimately, default.

Germany’s insistence on austerity for struggling allies in exchange for financial support—and on steep losses for the creditors of insolvent sovereigns—unleashed a credit crunch that has now spread from the periphery to banks, and now to French debt.

Heavily indebted countries tied to the puffed-up euro can’t devalue their way to growth. The only alternative route to competing with the likes of Germany is by way of a painful deflation of salaries, prices, and living standards.

Greek riots suggest that even a desperate nation can’t stomach that; and Italy and Spain are hardly desperate yet.

And while the European laggards lack the will to become so much more German, Germany and its affluent allies in Austria, the Netherlands, and Finland are unwilling to subsidize southern waste and inertia any longer.

Even if Germany and its AAA-rated friends (other than France) were to turn overnight into models of selfless generosity, the rescue fund as currently envisioned would look insufficient.

Germany and its rock-solid satellites owe less than €300 billion to the rescue kitty, while the other contributions are suspect because the donors might need rescuing themselves—and that includes the €158 billion due from France, which seems certain to get downgraded sooner than later.

More than €100 billion of the rescue money is already committed, or soon will be, to Greece, Portugal, and Ireland, and the rest, if leveraged 5 to 1, might be just enough to fund Italy and Spain for the next 20 months or so. But that assumes that private investors would accept new Italian guarantees for Italian bonds at face value, an outcome that seems uncertain, not to say improbable.

As for the banks sitting on all that unwanted Greek, Italian, and Spanish debt, they’re now deemed in need of a mere €80 billion in extra capital, which, at roughly one-third of outsiders’ estimates for the capital shortfall, won’t persuade those outsiders to lend the banks more money. The banks, in turn, are responding by cutting credit lines and raising rates, even for clients such as Porsche.

The German economy seems headed for a recession that will spare no one—certainly not Spain, where a longstanding property bubble is already imploding.

The truth depressing European bonds and banks is that even if the problem borrowers made all the structural adjustments demanded of them overnight, it’s not clear they would see much growth. Those adjustments would be most effective in combination with a debt restructuring and a cheaper currency, and the latter is strictly verboten because of Germany’s strong-money fetish.

The way things are going, that strong currency will soon be the deutsche mark once again. And then the vaunted German exporters, deprived of their subprime buyers, will suddenly find their workers unaffordable.

The ECB won’t have sullied itself with asset purchases like those cravenly amoral Anglo-Saxons. It will, however, keep accepting Greek bonds as collateral from Greek banks. And that’s the distinction over which Germany is willing to impoverish Europe. 

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