Walker's World: Euro crisis turns surreal

By MARTIN WALKER, UPI Editor Emeritus  |  Oct. 24, 2011 at 6:43 AM
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PARIS, Oct. 24 (UPI) -- The euro crisis is becoming surreal in that everything that possibly could go wrong is now doing so, all at once.

The French and Germans, who command the resources of the eurozone's two largest economies, are at loggerheads. If they cannot agree on a policy, nothing gets done in Europe.

The French insist that the European Central Bank start creating money to finance the next phase of the endless euro rescue. The Germans decline, adding that their constitutional court says this couldn't be done legally, even if Berlin wanted to. And it doesn't.

The troika -- financial experts from the European Commission, the European Central Bank and the International Monetary Fund -- has reported that Greek debt is spiraling much faster than envisaged and the Greek economy is shrinking faster than anyone feared.

The troika report, delivered Saturday to the Brussels summit of European leaders and finance ministers, warned that the Greek bailout could require as much as $611 billion by 2020. This means Greece alone would take up all the funds available to the European Financial Stability Facility, which was supposed to be available for Portugal, Ireland and possibly Spain as well as Greece.

"The situation in Greece has taken a turn for the worse, with the economy increasingly adjusting through recession and related wage-price channels, rather than through structural reform-driven increases in productivity," the troika report said.

Even to get the Greek debt down to 120 percent of gross domestic product by 2020, private lenders to Greece would have to suffer a "haircut" or a loss of 50 percent of the money they lent, the troika added. And 120 percent of GDP is twice the level that the eurozone rules say should be the limit for a national economy.

These private lenders are mainly the European commercial banks, led by the French banks but with the German banks also at risk. For them to take such a cut, at a time when new bank regulations are requiring them to increase the amount of capital they hold (and thus to reduce the amount they can lend), will be very damaging indeed.

It means a credit crunch as the banks cut back on their lending to other European borrowers. That cuts down on Europe's dwindling hopes of growing out of this crisis.

It also means that these banks will have to raise fresh capital, at a time when their share prices and their credit ratings are low. Raising funds won't be easy and will probably be expensive. Some banks have already said they would rather shrink in size.

In the case of France, it is particularly difficult. Usually, French banks might expect their capital shortages to be restored by cash from the French state. But because of high debt levels the French state's own ratings are already at great risk of losing their AAA status. If that AAA status is lost, France will find it harder and more expensive to borrow on the global markets.

France simply has too many liabilities and cannot afford any more. That is why France wants the ECB to do any more bailing out, rather than the European member states like France. And the situation is so fraught that even re-capitalizing its own banks could send the French government's ratings down.

And at that point, the EFSF itself would be in trouble, since France's contribution would no longer be worth what it was.

What all this means is that the Greek crisis alone threatens to overwhelm the entire eurozone. It used to be thought, as recently as last week, that the danger of the Greek crisis was that it would start a cascade of other crises in Portugal, Spain and Italy. It still could. But Greece alone looks as if it could be sufficient to torpedo the euro.

The bad news doesn't end there. Italy's bond yields are back up to 6 percent, which for an economy at zero growth means that they are on the point of being too expensive to afford.

Portugal's finance minister announced Friday that he expects his country's economy to shrink by 2.8 percent next year after contracting 1.9 percent this year. This makes it all harder for Portugal to repay its debts. Accordingly, interest on Portugal's 10-year bond yields climbed to more than 12 percent Friday.

Defaults on loans in Spain rose to 7.14 percent Friday, an 18-year high.

Oh yes, and the troika reported that the hopes of raising $83 billion from privatizing Greek state-owned assets now looks like bringing in at least $28 billion less.

The latest leak from the Brussels summit meeting was that Europe's leaders were talking up the prospect of rising new cash from the sovereign wealth funds of Norway, the Middle Eastern countries and China. The question has apparently not been asked why these countries would want to risk their money when European leaders won't.

The most surreal part of the saga came this week from EU Internal Market Commissioner Michel Barnier, of France. In a confidential planning document that was leaked to the German media last week he suggested that EU financial authorities be given the legal right "temporarily to prohibit" the rating agencies from publishing reports suggesting that European member states might not be able to repay their debts.

Shooting the messenger is seldom a good idea. The surreal part is that Barnier also suggests that the ratings agency be liable for the economic costs that result from their analyses. Faced with penalties for telling the truth, the ratings agencies are left with the choice of silence or lies.

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