While Moody’s warns of a significant risk of multiple defaults and a eurozone breakup, Angela Merkel and Nicolas Sarkozy want to impress the world with a new stability pact. This is what several German and French newspapers reported over the weekend. It seems to us that the political space and the actual crisis are moving in two disconnected parallel universes. The financial markets care little about another stability pact, while Merkel and Sarkozy care little about the imminent liquidity squeeze. The FT has a story this morning about the severe retrenchment of the financial sector, which has already produced a credit crunch in the eurozone. Paul Krugman says that the policy maker’s narrative was inconsistent with a recovery. Wolfgang Münchau says that the EU has about 10 days left to save the euro, and the discussions are currently moving in the wrong directions.
The news of Moody’s warning came in this morning La Repubblica reports that Moody’s said there is now significant risk of multiple defaults inside the eurozone, which could lead to a breakup, with several countries forced to leave the eurozone. Moody’s said the longer the liquidity crisis continued, the greater the risk of default. FT Alphaville has more details on this story. In its release Moody’s also notes that “the political impetus to implement an effective resolution plan may only emerge after a series of shocks, which may lead to more countries losing access to market funding for a sustained period and requiring a support programme. This would very likely cause those countries’ ratings to be moved into speculative grade in view of the solvency tests that would likely be required and the burden-sharing that might be imposed if (as is likely) support were to be needed for a sustained period.”
Eurozone banks face huge funding gap
The FT has an analysis on the funding gap by eurozone banks. So far this year, banks have only rolled over $413bn out of a total of $654bn, leaving a funding gap of $241bn. The articles quotes Huw van Steenis of Morgan Stanley as warning about a credit crunch in the eurozone, with knock on effects for the US. Next year, the banks have to roll over even more – $720bn.
Merkel and Sarkozy are working on a “Plan B” fort he Eurozone
According to Welt am Sonntag Angela Merkel and Nicolas are working on a “Plan B” for the Eurozone in case the debt auctions this week will flop, the attacks against the euro will continue and leveraging the EFSF to a sufficient size will prove impossible. This plan could include beefing up the budgetary rules and stiffening the sanctions. In return, the paper reports, the chancellor would be more open to Eurobonds and to an enhanced role of the ECB in managing the crisis. The German government yesterday partially denied the report but the French press picked it up with references to French government sources.
Le Figaro reports that the new rules could be adopted as soon as January or February by the AAA-countries in the Eurozone to form a “club of the super Europeans”. In order to speed up the process, they could be adopted in the form of bilateral intergovernmental agreements on the model of the Schengen agreement. The agreement could include missions to the capitals to check whether they budgets complied with the rules and “real sanctions”, as budget minister and government spokeswoman Valérie Pecresse explained yesterday. On the other hand there would be a real European solidarity mechanism. “The discussions are about putting into place a European solidarity mechanism from 2013 onwards which for example could work on the principle of a super majority instead of unanimity in order to make its use more flexible”, a negotiator quoted by the paper said. This agreement would be proposed to all 17 euro countries. “Those who refuse them must draw the consequences about continuing to belong or not to the Eurozone”, the paper quotes a government source.
(Just a short note about the AAA-club. If this were true, it would be a recipe for a eurozone break-up, and be understood in those terms. The only “club” for which this arrangement would make any sense is the whole of the eurozone, without exception.)
At the same time, Les Echos runs a story in which a French presidential source denies plans reported by Journal de Dimanche according to which the Commission would be granted real supranational powers in inspecting national budgets. Sarkozy does “not have any intention at all to give supranational powers to the Commission”, the source said. However the source said there where debates about more “intrusive powers” concerning the euro countries’ budgets but those powers could be exercised by the Commission or the “Euro Council” after having been given an opinion by the Commission.
Krugman on the Merkel/Sarkozy approach to crisis resolution
In his blog, Paul Krugman tells a familiar tale about the eurozone crisis, how its origins arose through private sector imbalances. But he makes the important point that policymakers are not thinking about scenarios, and lack a narrative how their policy of fiscal retrenchment can be consistent with European recovery. (That, in our view, goes to the heart of the problem of the Merkel/Sarkozy initiative. The international capital markets are worried that the bank liquidity squeeze will cause a credit crunch and a depression. Talk about a stronger stability pact is pure poison in such an environment.)
Belgium finally has a budget deal
The political parties in Belgium finally struck a budget deal on Saturday, clearing the last hurdle to the formation of a new government. The deal came hours after ratings agency Standard & Poor’s downgraded Belgium’s credit to AA from AA+, Reuters reports. S&P said difficulties in Belgium’s banking system and the government’s inability to respond to economic pressures had contributed to the downgrade. Under the deal, Belgium would reduce its budget deficit to 2.8% of GDP in 2012 from 3.6% expected this year and balance its books in 2015. Elio di Rupo said that the country should have a new government by next weekend. However Belgium’s downgrade will still weigh on a bond auction planned for Monday.
The deal was welcomed by the press, though without enthusiasm. Commentators in the French-speaking press warn that while the budget deal exists on paper, the real test will be its execution. The Flemish press is also sceptical. De Morgen even criticises the deal for maintaining age indexation and, no increase in the retirement age.
Greek’s third coalition party backs austerity deal
The leader of the Greek far-right nationalist party Laos affirmed his commitment to the austerity and reform package agreed in October. In an open letter published in the party’s newspaper, Georgios Karatzaferis said he “supports the multiyear adjustment programme” that Greece has promised its international creditors in exchange for aid. Despite his declared support, Karatzaferis says that some elements of Greece’s existing program need to be reconsidered amid signs the current programme has not been entirely successful in fixing the country’s finances, Wall Street Journal reports. But the letter adds that any changes should be within the fiscal goals set out by the existing programme.
Jürgen Stark warns the ECB’s independence is in danger
In a “farewell interview” with Frankfurter Allgemeine Sonntagszeitung, ECB board member Jürgen Stark warns that the central bank’s independence is threatened by the current debates on how to rescue the eurozone. “The political pressure on the ECB is currently enormous”, he said. “There is an open debate about enlarging our tasks. That not only touches upon our independence, it even threatens it.”
The nomination of Benoit Coeuré as ECB board member could derail Jörg Asmussen’s chances to become the ECB’s chief economist
Last week’s nomination of France’s deputy treasury director Benoit Coeuré to succeed to Lorenzo Bini Smaghi on the ECB board could derail the German government’s plans to make the deputy finance minister Jörg Asmussen the next ECB chief economist, Financial Times Deutschland reports. Coeuré is a seasoned economist who has taught and published extensively in French and English together with other French economists of Keynesian inspiration throughout his career as a government official. Asmussen on the other hand has made himself a reputation as crisis manager and not as an academic economist. The paper points out that Mario Draghi and the board are free to decide on the attribution of portfolios in the board and that there was no pledge to Asmussen or the German government that the ECB’s third chief economist would yet be another German after Otmar Issing and Jürgen Stark. However Draghi may not want to antagonize Angela Merkel and give the portfolio to Asmussen despite Coeuré’s much more academic background, FTD notes.
Wolfgang Münchau says there are 10 days left to save the eurozone
In his latest FT column, Wolfgang Münchau argues that the EU has about 10 days to save the eurozone. With the spread of the crisis to the inner core, the flop of the German bond auction, and the dramatic rise in Italian and Spanish short-term rates, the crisis has now reached a new qualitative stage. Münchau says with a month that passes the cost of crisis resolution has gone up. It now requires three elements: a full ECB backstop;
a eurobond; and a fiscal union. He says it will be hard for Merkel to agree to such a package because she has continuously been ruling out eurobond, and even criticism the Commission for making a proposal. It will be very hard to get such a deal, and the usual fudges are not going to work this time.
Spreads, Forex, and ZC Swaps
The euro continues to fall.