Tuesday, 30 November 2010

More Dominoes Get Lined Up

A few days ago, I referred to the Irish Bail-out as Another Domino Falling. In that post, I set out why the idea, that the Irish Bail-out would stem the contagion to other EU peripheral economies, was a vain hope. Once Ireland was bailed-out, traders would necessarily turn to the next country whose ability to repay its debt looked shaky. That everyone agreed was Portugal. The terms of the Irish bail-out show why this is. The interest to be paid by Ireland is a not inconsiderable 5.8%, but the yield on Portuguese debt has already risen way above that. It would be cheaper for Portugal to accept a bail-out simply to cut its interest payments. Nouriel Roubini has already argued that Portugal should take such a course of action. What has been surprising, though, is the speed with which the markets have lined up additional dominoes to fall, even before attention has fully fallen on Portugal. Almost straight away, rumours began to circulate that Belgium would also need a bail-out, and almost by-passing Portugal, attention passed straight to Spain, and now there are murmurings of the need for an Italian bail-out, and even some suggestions that down the line France could come into focus.

Opinion is divided on what is and what is not possible. Roubini has said that because Portugal only accounts for around 2% of EU GDP – whereas Germany accounts for more than 30% - it could be easily dealt with, but he says that Spain is too big to bail-out, whilst also saying it is too big to fail. On the other hand, Jim O'Neill, of Goldman Sachs, says that if Germany does not want the Euro to fail, and it doesn't he says, it will have to find a way of bailing-out Spain, and perhaps others. It is becoming clear, as I suggested earlier in the year, that the Bank Stress tests were a sham. They failed to deal with the one question they needed to address – how resilient were these banks in the face of a sovereign default. In fact, what we have now is the potential not just for one sovereign default, but of multiple defaults, or at least partial defaults as debt is restructured. It is now becoming clear that both Portuguese and Spanish Banks need huge recapitalisation, exactly what led to the problem for Ireland. If they go down then German Banks who have large positions with these banks will also be badly affected. At the moment Germany is booming, it is in German interests to resolve this crisis not allow it to escalate, and threaten bringing its own economy down with it.

What is interesting is that on the BBC News Channel's Business slot today, David Buick, of City Firm BGC Partners, spelled out the real problem. Buick can normally be relied upon to give a response that follows closely the Tory Party line. However, today his comments were revealing. The problem in Ireland, he said, was that they were being asked to pay 5.8% on this bail-out, which is hardly a low rate of interest, compared with the 2% or so that Germany pays. But, he said, at the same time, its economy, which was already in trouble, is being sent further into recession as a direct result of the austerity measures it has already taken, let alone is being asked to adopt. As a result, the chances of it being able to generate the economic growth, which would enable it to pay the interest on that debt is remote. The result is that its position is likely to worsen, and that is why the yield on its Bonds is continuing to rise. But, that argument applies across Europe, apart from Germany, and one or two other economies, not including the UK.

What we have is, in reality not an economic crisis, but a political crisis. In part, what we have is Germany using its position to force a restructuring of Europe. If individual EU countries agree to submit to the idea of a more centralised, Federal Europe, with centralised decision making over Budgets, then the problem can be resolved over night. Germany can bail-out those economies requiring immediate support in return for a planned programme of growth, and fiscal responsibility i.e. cutting deficits over a given period, and the ECB can be imposed upon to simply print money to monetise the existing debt, thereby essentially forcing Bond holders to take a haircut as a result of being repaid in devalued currency, but which they are likely to accept as preferable to actual defaults or rescheduling, and which they will in any case recoup as yields on longer dated paper being issued will rise – though still being nowhere near the rates peripheral economies are currently facing. It would also stabilise the Euro overnight, at a more competitive level against the dollar. But, the reason it is a political crisis is precisely because there is, and would be resistance from various groups within the respective nation states to the idea of giving up “sovereignty” and the establishment of a Federal Europe. One by one individual states are being forced to accept that there is no real alternative to such a solution. Britain, might think it can escape that logic, but ultimately, and perhaps in the not too distant future, it will face the same question. It will be a matter of in or out of such a Europe. If it chooses to be out, then the consequences would be severe.

But, as I've pointed out before, none of this should lead us to lose sight of the wider picture. An article in the Weekly Worker last week, about Ireland, located it within the context of a global crisis of Capitalism. Yet, the reality is that no such crisis exists! China is growing at 10% p.a., latest data out from India shows it growing at more than 8%. Latest data also suggests that the fiscal stimulus in the US, alongside the Quantitative Easing, is beginning to feed through. Figures on growth, and on jobs have begun to strengthen. Moreover, an article in the FT at the weekend shows the danger of being too hung up on the old world economies. We used to talk about the Asian Tiger economies, as emerging markets, but many of these today now have to be described as having emerged. A few years ago, Jim O'Neill coined the phrase BRIC to refer to Brazil, Russia, India and China. Now analysts are looking for similar terms to cover the new emerging economies, variously described as the Next 11, or 15. These economies include Vietnam, Turkey, Egypt, Colombia and others in Africa. Some of these economies are growing even faster than China. One US commentator on CNBC earlier today spoke of the danger for Europe, as its austerity measures result in stagnant growth, whilst the US increasingly turns its eyes towards developing trading links with these new and rapidly developing economies, many of whom China already has built bilateral links with.

The reality is that European leaders are dithering. The US already has a centralised Federal State. It takes decisions accordingly. China has a similar set-up, with the further benefit of a still largely planned economy, or at least directed economy. The smaller economies have the advantage of being new and dynamic, and so do not currently face the problems that the large economies face. In Europe, apart from Germany, the national economies are old and decrepit. They have not restructured during the long-wave downswing to meet the challenges of the new Boom. They could still do so, as the US will need to do, provided they took decisive action to establish a centralised Federal State. If they do not, and fail to then take the necessary measures, then the problems that David Buick outlined in relation to Ireland will spread to much of the EU economy, including the UK.

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