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EuroTARP Faces Criticism

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May 10, 2010

Who would have thought that Mother’s Day would coincide with the announcement of a 720-billion-euro bailout fund to resolve the sovereign debt crisis in the European Union?  Here’s how The New York Times broke the story:

In an extraordinary session that lasted into the early morning hours, finance ministers from the European Union agreed on a deal that would provide $560 billion in new loans and $76 billion under an existing lending program.  Elena Salgado, the Spanish finance minister, who announced the deal, also said the International Monetary Fund was prepared to give up to $321 billion separately.

Officials are hoping the size of the program — a total of $957 billion — will signal a “shock and awe” commitment that will be viewed in the same vein as the $700 billion package the United States government provided to help its own ailing financial institutions in 2008.

The package was much higher than expected, and represented an audacious step for a bloc that had been criticized for acting tentatively, and without unity, in the face of a mounting crisis.

*   *   *

Financial unease has been mounting.  Riots in Greece, ever-tightening terms of credit and the unexplained free fall in the American stock market last Thursday have compounded the sense that the European Union’s inability to address its sovereign debt crisis might lead to the type of systemic collapse that followed the fall of Lehman Brothers.

The debt crisis began with Greece teetering toward default, and fear quickly spread about other weak economies like Portugal, Spain and even Italy.  Previous efforts by the European Union to shore up investor confidence were viewed as too little, too late, with the markets making clear that they were looking for a bolder plan.

Ambrose Evans-Pritchard of The Telegraph provided us with an informative, yet critical look at the plan:

The walls of fiscal and economic sovereignty are being breached.  The creation of an EU rescue mechanism with powers to issue bonds with Europe’s AAA rating to help eurozone states in trouble — apparently €60bn, with a separate facility that may be able to lever up to €600bn — is to go far beyond the Lisbon Treaty.  This new agency is an EU Treasury in all but name, managing an EU fiscal union where liabilities become shared.  A European state is being created before our eyes.

No EMU country will be allowed to default, whatever the moral hazard.

*   *   *

For now, the world has avoided a financial cataclysm that would have been as serious and far-reaching as the collapse of Lehman Brothers, AIG, Fannie and Freddie in September 2008, and perhaps worse given the already depleted capital ratios of banks and the growing aversion to sovereign debt.

*   *   *

The answer to this — if the objective is to save EMU — is for Germany to boost its growth and tolerate higher ‘relative’ inflation.  This would allow the South to close the gap without tipping into a 1930s Fisherite death spiral.  Yet Europe will have none of it.  The weekend deal demands yet more belt-tightening from the South.  Portugal is to shelve its public works projects.  Spain has pledged further cuts.  As for Germany, it is preparing fiscal tightening to comply with the new balanced budget amendment in its Grundgesetz.

While each component makes sense in its own narrow terms, the EU policy as a whole is madness for a currency union.  Stephen Lewis from Monument Securities says Europe’s leaders have forgotten the lesson of the “Gold Bloc” in the second phase of the Great Depression, when a reactionary and over-proud Continent ground itself into slump by clinging to deflationary totemism long after the circumstances had rendered this policy suicidal.  We all know how it ended.

Back here in the United States, Karl Denninger of The Market Ticker pulled no punches in criticizing the idea of attempting to solve a debt crisis by creating more debt:

This package was calculated to bring about a market reaction similar to what our Federal Reserve and Congress did in 2008 and 2009.  The problem is that the ECB and EU are not similarly situated, in that they don’t have (in the opinion of the market) a solid balance sheet to lever up upon.  Indeed, the problem is within the sovereign balance sheets upon which the EU and ECB rest, and as such this little “program” announced this evening leads me to wonder:

Do they really think the markets are stupid enough to fall for this line of Ouroboros nonsense?

I guess we shall see if, in the coming days, the markets discern the truth of where the funding has to come from, and that in point of fact it is the very nations that are in trouble that have to – somehow – manage to both cut their fiscal deficits and sell more debt (which increases those deficits) to fund their package.

Indeed, I suspect Bernanke and his pals “re-opened” the swap lines not because of current dollar funding problems (there aren’t any) but because he knows this won’t and can’t work, as unlike in the US there is no strong balance sheet to which the debt can be transferred and then refinanced at a lower rate, unlike in the US.

Ben Bernanke would probably hate to see all his hard work at devaluing the dollar go to waste.  One of his worst nightmares would likely involve the dollar’s rise above the value of the euro.   American exports to Europe would become too expensive for those 55-year-old retirees.  Europeans wouldn’t be taking their holidays in America this summer because it would become too expensive, given the new exchange rate.  Whether or not EuroTARP really works as intended, there are plenty of people on Wall Street anticipating a huge rebound in stock prices this week.



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