Latest from Europe: Calming Markets, Fire Escapes and Collateral for China

Econintersect:  The relief rally from relaxing the extreme anxiety in Europe continued Thursday, with markets around the world showing gains for the third day in a row. Almost everything has remained green in global markets as shown in the market summary screen after the continuation break. However, in spite of the reaction of global stock markets much of the crisis response still remains in limbo.  A sober assessment of the facts leads one to conclude that somewhere between 50% and 100% of the principal on Greek bonds will be forfeited and the interest rates commanded by traders in the open market (20% to 50%) will never be paid as well.  The assessment of the impact on European and global banking remains much in doubt.The past few days GEI News has reported on new developments daily and less frequently in the months before. News today comes from a variety of sources.

First, the strong markets continued Thursday.  The following snapshot was taken from GEI Current Market Conditions Newspaper at 10:28pm New York time showing prices after all markets had closed for September 15, 2011.

The prospects of a European TARP were addressed by GEI News yesterday and today Business Insider had a good summary of the topic.  Here is some of the BI article:

Spain and Italy’s borrowing costs are spiking once again despite the ECB’s efforts to curb bond yields through bond-buying. This plan could take center stage at a conference of EU financial ministers and U.S. Treasury Secretary Timothy Geithner in Wroclaw, Poland tomorrow.

If eurozone officials think such a plan would be successful at calming markets, this could form the basis of a new endgame for addressing the sovereign debt crisis.

According to Reuters, Geithner will also reportedly suggest leveraging the EFSF — much along the lines of the TALF program the U.S. used in order to bolster public money with central bank money.

“It could help those countries where the sovereign bond market is still curable,” said a euro zone official cited by that Reuters report.

By letting private investors invest alongside public money, such leveraging could expand the resources available to the EFSF to bolster banks or buy bonds past the $611 billion the fund already has at its disposal. Analysts have repeatedly commented that this sum is too small to prevent contagion from spreading across the eurozone.

Both plans require significant political will, however, as they rest on approval of the July 21 agreement to expand the powers of the EFSF. A TARP-like program would also require EU leaders to admit that European banks are not properly capitalized, which — without a viable plan — could send the market into freefall. At this point, this all feels very hopeful, rather than something that is imminent.

One really has to ask if Geithner’s leverage idea is all that good.  Just yesterday GEI News reported on the fact that European banks have more than three times the leverage of American banks.  Isn’t there something connecting risk and leverage?

Philip Pilkington has asked a very interesting question in an article at Independent.ie:  “Are wily Germans really looking for the fire escape?”  Philip discusses the reaction of several notables, including Wolfgang Munchau at The Financial Times, to the German court ruling a week ago that apparently has the effect of closing off the possibility of issuance of euro bonds.  Such a move would be obviously a big step toward some sort of fiscal union for the EU, allbeit possibly very contrived and contorted, especially at first.

Yet, as discussed in a GEI News article yesterday, Jose Manuel Barroso, the president of the European Commission, came out saying that a proposal would soon be made regarding euro bonds. However, he conceded that this would require significant changes to present EU treaties, probably in recognition of the German court ruling.

All of this brought Pilkington to the fire escape analogy.  He wrote:

Meanwhile, former ECB official, Jurgen Stark said earlier this week that Ireland needs… you got it: more austerity. One can only wonder whether Stark understands that increasing austerity will prove counter-productive as it will further dampen economic growth in the countries with sovereign debt crises and ensure that it becomes even more difficult to collect sufficient tax revenue to make debt payments.

If he doesn’t understand this then he’s living in fantasy land, ignoring most serious global economists and simply trying to pass the buck on to national governments. If he does understand this then he may be construed as encouraging the engineering of a peripheral depression in the euro area. Neither is savoury. And both reflect a self-destructive dynamic — the former, political; the latter, economic.

The call for austerity-without-end is becoming increasingly shallow. In fact, it’s coming to look like an evasive tactic on the part of certain European figures to allow them to avoid the responsibility they hold for keeping the whole thing together.

This way, if the system burns, they can simply fob off the blame on national governments who they will claim weren’t austere enough. This may work politically — in the short-term, at least — but it will prove to be a disaster economically.

When Europe burns, Germany can simply flee down the fire escape.  Of course, the German economic house will be much less valuable once the rest of the neighborhood is turned to ashes.

Pilkington goes on to conclude that the Germans may end up standing aside while the ECB runs the “printing presses” to create enough devalued euros to backstop all the banks that could go belly up with substantial sovereign defaults.  That way Germany does not have a direct assumption of responsibility for debt in the periphery.  They simply have to live with a decimated currency, a survivable condition as opposed to the economic suicide of blocking the ECB action and ending up the only house in a fire zone destroyed neighborhood.

Pilkington goes on to suggest a way out:

There is another way around all of this tedious political and legal wrangling, however; one that’s only being talked about by a very small number of people. The individual nations that are currently facing funding problems could issue ‘Mosler bonds’.

Here’s how it would work: the nations would issue new bonds that contain a clause that says that, in the case of a sovereign default, they can be used to extinguish tax liabilities in the country of origin. This would mean that the bonds would always be absolutely guaranteed to be worth the value stated and this would calm down investors in the markets. This, in turn, should bring bond yields down significantly and prevent sovereign default.

Mosler bonds would allow countries to regain control over their sovereign debt and stop them from depending on European-wide institutions — and they could do this without having to exit the single currency. What’s more Mosler bonds would probably prove quite popular with European politicians as they would be seen by voters as allowing countries to ‘pay their own way’. Mosler bonds can also be issued by the nations themselves; and that means they can be implemented very quickly; needless to say, in the present environment speed is essential.

The only impediment to the adoption of Mosler bonds is a severe lack of awareness. Hopefully commentators and politicians will start catching up with the idea before it’s too late.

Mosler’s bond proposal was published at Global Economic Intersection Opinion Blog on July 11, 2011.

Finally, a follow-up to the news about the discussions that China has had with both Greece and Italy about investing in their sovereign debt, which has been reported in GEI News.  According to Alan Valdes China is not likely to just buy European debt the way they have bought massive amounts of U.S. debt.  In Europe the Chinese will want collateral, says Valdes.  Here he is in a video from TheStreet.com:

Click on image to play video.

So what Greek collateral will China be able to get?  Would they find the Parthenon to be worthy?  How about a few Greek isles staffed with toga and sandal clad indentured servants to provide vacation venues for fifty million Chinese tourists a year?

And in Italy?  What about the colloseum to be refitted for the next Chinese Olypmics?  Or maybe the Isle of Capri for the same treatment as the Greek isles?  Italy does have a distinct advantage over Greece – Italy has Cortina D’Ampezzo which could be used as the site of the first Chinese Winter Olympics.  Or even Torino, if more collateral is needed.

Sources:  Business Insider, Independent.ie, GEI Opinion, The Street.com, GEI News: and GEI Current Market Conditions Newspaper