December 5, 2011

6 Horsemen? Central Banks Dollar Liquidity Only Prolongs The Euro Debt Crisis

By EconMatters

Stock markets soared after the coordinated actions on Wed. Nov. 30 from six central banks around the world -- the Federal Reserve, European Central Bank (ECB), and the central banks of Canada, U.K., Switzerland, and Japan -- to provide "temporary U.S. dollar liquidity swap arrangements." Those dollar swap lines and programs are authorized through 1 Feb. 2013.

Whenever there are six central banks acting in concert, it typically suggests something serious either already taken place or underway. Some analysts and market experts speculate that there could be a run on European banks, and an imminent collapse of the euro.

But the show of force by central banks propped up stocks, commodities rallied, and yields on most European debt also fell.  The dollar swaps made it cheaper for banks to borrow dollars in emergencies, and is meant to ease the credit crunch in the financial markets, business, and individuals, instead of a "bailout" of the Euro Zone.

One latest development reported by Reuters is that Germany's Finance Minister Wolfgang Schaeuble intends to present at a crunch summit of EU leaders on 9 Dec:
"Each of these countries should put into a special fund that part of its debt which exceed 60 percent of its GDP, and should pay that off with tax revenues. Over a period of 20 years, the debt should be reduced to 60 percent," he [Schaeuble] said.
Schaeuble believes his proposal, which has won qualified support from Chancellor Angela Merkel, would boost confidence as states would be sending a signal they were serious about limiting debt levels to 60 percent of gross domestic product.

At first brush, it seems more of a wishful thinking that Schaeuble's plan would "boost confidence" of investors.  The separation of excess debt to be paid off with tax revenues over 20 years, while symbolic, does not really change the fiscal fundamentals leading to the current crisis in the region--sluggish growth, high debt with a significant portion maturing in the next five years, and the prospect of renewed recession, including Britain and Germany-- as illustrated by the interactive charts below from The Economist (updated 12 Nov 2011).





Another development as reported by NYT is that European leaders are running to the International Monetary Fund (IMF) for help. However, the IMF, in the same boat as the ECB, does not have the resource to really insulate interest rates from further deteriorating at troubled euro zone countries.  Furthermore, any way you slice the numbers, the existing IMF funds just won't work:
"Italy and Spain together have total debts of more than $3.3 trillion, with Italy about to roll over $276 billion in debt over in the next six months and Spain about $150 billion.  Just those two rollovers would wipe out the amount the fund has available to lend worldwide, about $400 billion."
To increase IMF funds, support from the United States and China would be necessary.  But the international community has lost patience with the Euro Zone's political indecisiveness for the past 2+ years.

The U.S. so far has signaled a position of no plans to make bilateral loans to the IMF to help stem the Euro crisis.  Treasury Geithner said on 15 Nov.:
“It’s Europe’s crisis.  Fundamentally, the resolution of this is going to depend on the choices they make going forward. And we hope they make some progress more quickly.”
Moreover, asking Congress for more money to bail out Europe would be an extremely ill-advised move for President Obama, particularly in an election year.

As for China, the country with largest reserves in the world, Bloomberg quoted China's Vice Foreign Minister Fu Ying as noting (emphasis ours),
China can’t use its $3.2 trillion in foreign exchange reserves to “rescue” European nations and [China] “has done its part” to help the region deal with its financial crisis... The argument that China should rescue Europe does not stand.”

The European union, combined, has enough resource to dig themselves out of this mess if they put their economic (vs. political) minds to it. But it all comes down to money, and the rich Germany is not going to take on more risk without serious austerity commitments from the high-debt peripherals. But countries such Greece, Spain and Italy all are having difficulties pushing through some heavy-duty austerity reform after years of living beyond their means.  

Meanwhile, Geithner will travel to Europe, ahead of the EU Brussels Summit on 9 December, to push the Europeans for quicker and more decisive action.  Nevertheless, most likely, the EU will act just the opposite of whatever message Geithner's trying to deliver, even if solely just to avoid the appearance of bowing to the U.S.

There are hard decisions that need to be made long ago, and when push comes to shove, they will get implemented quite swiftly by EU. However, the new dollar liquidity injection from six central banks essentially took the urgency out of a much needed decisive resolution, and the so-called crunch summit, like almost all multi-national summits, most likely would end up with very little accomplished.

According to Reuters, "Germany is dead set against any pooling of responsibility for debt within the euro zone" (i.e., the Euro Bond).  On the other hand, Germany would not like to see a breakup of euro either as German export business has benefited tremendously from the Euro's "weaker sisters" artificially pushing down the Euro much lower than German's own currency would have been.

So there are very limited viable options left for now.  Eventually, the Euro crisis probably could result in one or a combination of the following scenarios:

  1. Some kind of international aid that the U.S. and China would most likely be involved in some extent, whether they likes it or not, since the crisis has evolved into such a threat to the global economy and financial stability.  
  2. Exit of some or all of Weak Sisters of the EU.  Greece and Italy would be the two on the short list.   

And there's this remote possibility we might hear something unexpected and surprising out of EU, as most important decisions are typically made behind closed doors, and this summit could just be a media distraction?

Some additional thoughts...

The Euro debt crisis has highlighted one common critical issue of all governments in the world--unlimited tax revenue money with very little related accountability.

In the corporate world, if a company can't properly balance its cashflow or has done something ill-conceived, shareholders would send a message by dumping the company stock en masse  (The recent Netflix stock movement is a prime example), which would act as a fabulous incentive for company management to get their acts together very quickly.

However, in the case of government, regardless how much the government mis-managed a nation's finances, taxpayers have very little power to send a strong enough message.  Government basically just has this unlimited (in most cases, increasing) tax revenue income year after year without the accountability and incentive of proper and efficient fiscal management.  

Until there's a fundamental and structural change of how government is held accountable for running and managing a nation's resources, there could be more crises similar to the one in the Euro Zone popping up to the point of one Scary Grandioso--No more spare bailout capacity.

Further Reading:
Euro Bond: Europe's Only Way Out For Now
Expect A Global Recession No Matters What Happens In The Euro Zone

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