European Union leaders have agreed to write off 50% of Greece’s debt, while bolstering the EU bailout fund to 1 trillion euros ($1.32 trillion).
Greece’s debt will be reduced to 120 billion euros by 2020, while French and German banks, which are exposed most to Athens’ sovereign debt, will absorb the largest write-downs.
As punishment for their profligacy, financial institutions such as the Banque Nationale de Paris (BNP), Credit Agricole and Deutsche Bank will be forced to raise more than 100 billion euros privately in recapitalisation funds by June 30 next year.
What is interesting is how the Germans flexed their considerable financial muscle at this summit.
French President Nicolas Sarkozy may have announced the deal, but German Chancellor Angela Merkel clearly controlled the agenda.
In fact, Merkel was crystal clear for weeks in stating unequivocally what Germany would not agree to. Domestically, this was critical to her strategy of ensuring support from the German parliament.
There would be no bailout by the European Central Bank (ECB), Merkel declared. In any case, legally, the ECB cannot be responsible for sovereign debt.
The German Chancellor also resisted calls from both the United States Treasury and public and private-sector economists to increase the size of the European Financial Stability Facility (EFSF) bailout fund, long rumoured to be as vast as 2 trillion euros or even 3 trillion euros.
Early signs are that the markets are cautiously optimistic that the EU has, at last, done something concrete.
As I previously noted, the minimalist bailout fund and the 50% haircut for the banks is merely a “bazooka”, as one finance minister put it. It buys the EU time to consider more radical measures, but nothing more.
Nobody in Brussels wanted to pull the “nuclear trigger”: that would involve creating that costly 2 trillion euro or 3 trillion euro treasure chest.
More to the point, nobody wants to pay for it, for fear that contagion could lead markets to target the precarious PIIGS (Portugal, Ireland, Italy and Spain) next.
Fixing the Eurozone
A veritable Who’s Who of the economics commentariat has weighed in recently with all manner of schemes to fix Europe’s faltering finances.
On one side of the debate, Nobel laureates Paul Krugman and Joseph Stiglitz have urged expansionary budgets and looser monetary policy, which largely mirrors the unwelcome advice US Treasury Secretary Tim Geithner has pointedly offered his EU counterparts.
Essentially, all four men have made the same point: the ECB should step in and assume responsibility for EU sovereign debt by buying it up. That, Soros reasons, would remove debt uncertainty and eliminate market-based risk.
The problem is that the ECB has tried this already. Following the 2008 global financial crisis, the ECB ran a covered bond program (bank debt backed by loans), where the ECB bought over 60 billion euros from banks in an attempt at providing finance sector stability.
Moreover, in its Securities Markets Program (SMP), which began in May 2010, the ECB purchased more than 76 billion euros in sovereign debt bonds from Greece, Ireland and Portugal.
The kicker is that Soros argues that the “ECB [should] stop open market purchases” of debt. In effect, this amounts to the virtual “nationalisation” of EU sovereign debt by European financial institutions.
Bold words indeed from the man whose hedge fund “broke the Bank of England” during the September 1992 EU currency crisis. Soros short-sold 10 billion pounds against the likelihood of the bank raising interest rates and pocketed more than 1 billion pounds in profit inside a week.
In those seven days in 1992, Soros, together with the electronic herd of currency speculators, drove the pound out of the EU Exchange-Rate Mechanism (ERM), forced the Bank of England to raise interest rates to 15% and left an abiding suspicion of the Eurozone in City of London and Westminster.
The British pound spent barely 18 months within the ERM (membership of which is a precondition for Eurozone membership). No British government since then has ever attempted to return.
Soros’ trail of destruction did not stop at the English Channel.
The September 1992 crisis also saw Italy’s lira bounced out of the ERM (to return, belatedly, in 1996). The French franc survived, barely, following a grudging 0.25% German interest rate cut.
In an abortive attempt to defend the krona, the Swedish central bank raised interest rates to 500% in a single day. Quizzed by the financial press as to how high Swedish rates would go, the finance minister replied, “the sky’s the limit.”
The only winners were foreign exchange speculators, who bought Porsches.
Ranged against Soros & Co. are German central bankers Axl Weber and Helmut Schlesinger.
Weber is the President of the powerful German Bundesbank and Schlesinger is his predecessor. Both of them have the ear of Merkel and senior German parliamentarians.
Weber and Schlesinger are both stolid believers in fiscal and monetary discipline as the cure to all ills. In this respect, they are very much the product of the conservative Bundesbank, long the yardstick for financial rectitude.
Their unlikely ally is former British prime minister Gordon Brown, who has called for the G-20 countries to develop a managed, trade-led global growth strategy so that job creation becomes the priority, while creeping protectionism is averted.
Weber was up for the ECB presidency until his hawkish views on EU monetary and fiscal policies drove EU leaders to choose the more dovish Banca Italia president Mario Draghi as Jean-Claude Trichet’s successor.
A house divided
What the Eurozone crisis has revealed is the seismic chasm between EU member countries, as well as its regional and domestic institutions.
Britain, not even a member of Eurozone, has just seen parliamentarians from the three major parties defy their whips and vote to hold a referendum on the UK’s membership of the EU. Although the motion was heavily defeated, the fact that it got this far is instructive.
Meanwhile, the Slovak parliament recently debated whether they had made the right decision in joining the eurozone.
Italy under Berlusconi has repeatedly toyed with the idea of withdrawing from the euro currency and reviving the lira.
In Paris, Sarkozy has been compelled to accept Merkel’s plan to address the eurozone crisis at the expense of French banks. Ultimately, this not only relegates France to the unusual position of second banana, but may also cost Sarkozy his job.
Finally, at the ECB in Frankfurt, Jean-Claude Trichet and Axl Weber are barely on speaking terms.
Europe à la carte – multispeed Europe – was always going to be the consequence of integration amongst unequal partners. Wealth redistribution was the price of bringing the PIIGS into an integrated European economy.
But no economist ever predicted that the cost of maintaining the Eurozone would prove so astronomical.