LAST week in this column I anticipated the summit meeting of the 17 heads of the eurozone, held in Brussels on Friday.
This get- together aimed at nothing less than a root-and-branch reform of how the euro currency area operates - which explains why I was sceptical that very much would be achieved.
On the one hand, the summit desperately needed to agree a permanent successor to the European Financial Stability Facility, the temporary bailout mechanism the eurozone introduced last year to keep Greece and Ireland from defaulting on their sovereign debts.
At the same time, the summit needed to accommodate the Germans, who would have to fund any permanent bailout system. Berlin wanted tough curbs on the profligate lending of the weaker eurozone members, an end to Ireland's low corporate tax regime and even a common European retirement age to stop other eurozone members funding their welfare states at Germany's expense.
Now for the big surprise: the summit appears - I use the word advisedly - to have struck a deal in the early hours of Saturday. A deal that seems to give everyone what they want.
As a result of this speedy resolution of the crisis, the bond markets began to relax.
What did the summit agree? There is to be a new, enlarged bailout fund starting in 2013, called the European Stability Mechanism (ESM). This will have €500 billion (£435bn) to lend to eurozone governments in financial trouble. Translation: private bondholders will get their money back.
In addition, the eurozone counties agreed to a tough new "pact for the euro" that commits them to caps on government spending but also significant labour market reform. This involves lowering wages to match domestic productivity levels, lower taxes on labour, linking pensions to life expectancy and greater harmonisation of business taxes. Translation: Berlin got its quid pro quo.
The spin put on the new plan was wholly positive. Even the bond markets were taken in, which - of course - was the point. However, closer perusal of the deal suggests it is yet another Euro-fudge based on tough talk but soft conditions.
For a start, the deal on spending curbs and economic reform is purely voluntary. It is no more enforceable than the original European fiscal stability pact signed when the euro was inaugurated. Worse: the terms established for creating the new ESM bailout fund contain an Achilles' heel that could trigger a fresh currency crisis.
To persuade Berlin to play ball, the ESM will buy only sovereign bonds on condition the loan is senior to previous debts; ESM money gets paid back before anyone else's, thus minimising the risk of providing the bailout. Why is that a problem?
Imagine you own Portuguese bonds. As of last weekend, you know that if Portugal ever needs to access ESM funds, your bonds will suddenly become second-class paper. Ergo, they are now worth less than before. The existence of the ESM should make Portugal less vulnerable.
On the other hand, your bonds carry more risk.
Until now, bondholders could count on Germany bailing out weaker members rather than risk the stability of the eurozone. But after 2013, Berlin could demand that any government accepting an ESM loan eventually go on to organise a managed debt restructuring.
In such a managed "default", the ESM loan would be guaranteed but private bondholders would have to take a financial haircut. Ask yourself: as the ramifications sink in, are bond markets going to be more or less worried as a result of this latest eurozone fudge?
Greek and Irish sovereign debts levels are unsustainable and need to be restructured - now. Portugal is drifting into this category and prolonged uncertainty over the euro could put Spain over the line.
The next big crisis could come in four months' time with the publication of the solvency tests for Europe's banks. Some day the fudges will have to give way to decisive action, or the euro is doomed.
Source: http://business.scotsman.com
This get- together aimed at nothing less than a root-and-branch reform of how the euro currency area operates - which explains why I was sceptical that very much would be achieved.
On the one hand, the summit desperately needed to agree a permanent successor to the European Financial Stability Facility, the temporary bailout mechanism the eurozone introduced last year to keep Greece and Ireland from defaulting on their sovereign debts.
At the same time, the summit needed to accommodate the Germans, who would have to fund any permanent bailout system. Berlin wanted tough curbs on the profligate lending of the weaker eurozone members, an end to Ireland's low corporate tax regime and even a common European retirement age to stop other eurozone members funding their welfare states at Germany's expense.
Now for the big surprise: the summit appears - I use the word advisedly - to have struck a deal in the early hours of Saturday. A deal that seems to give everyone what they want.
As a result of this speedy resolution of the crisis, the bond markets began to relax.
What did the summit agree? There is to be a new, enlarged bailout fund starting in 2013, called the European Stability Mechanism (ESM). This will have €500 billion (£435bn) to lend to eurozone governments in financial trouble. Translation: private bondholders will get their money back.
In addition, the eurozone counties agreed to a tough new "pact for the euro" that commits them to caps on government spending but also significant labour market reform. This involves lowering wages to match domestic productivity levels, lower taxes on labour, linking pensions to life expectancy and greater harmonisation of business taxes. Translation: Berlin got its quid pro quo.
The spin put on the new plan was wholly positive. Even the bond markets were taken in, which - of course - was the point. However, closer perusal of the deal suggests it is yet another Euro-fudge based on tough talk but soft conditions.
For a start, the deal on spending curbs and economic reform is purely voluntary. It is no more enforceable than the original European fiscal stability pact signed when the euro was inaugurated. Worse: the terms established for creating the new ESM bailout fund contain an Achilles' heel that could trigger a fresh currency crisis.
To persuade Berlin to play ball, the ESM will buy only sovereign bonds on condition the loan is senior to previous debts; ESM money gets paid back before anyone else's, thus minimising the risk of providing the bailout. Why is that a problem?
Imagine you own Portuguese bonds. As of last weekend, you know that if Portugal ever needs to access ESM funds, your bonds will suddenly become second-class paper. Ergo, they are now worth less than before. The existence of the ESM should make Portugal less vulnerable.
On the other hand, your bonds carry more risk.
Until now, bondholders could count on Germany bailing out weaker members rather than risk the stability of the eurozone. But after 2013, Berlin could demand that any government accepting an ESM loan eventually go on to organise a managed debt restructuring.
In such a managed "default", the ESM loan would be guaranteed but private bondholders would have to take a financial haircut. Ask yourself: as the ramifications sink in, are bond markets going to be more or less worried as a result of this latest eurozone fudge?
Greek and Irish sovereign debts levels are unsustainable and need to be restructured - now. Portugal is drifting into this category and prolonged uncertainty over the euro could put Spain over the line.
The next big crisis could come in four months' time with the publication of the solvency tests for Europe's banks. Some day the fudges will have to give way to decisive action, or the euro is doomed.
Source: http://business.scotsman.com
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