Euro sovereigns have been borrowing and spending to excess but the party can't go on forever. Could the rating agencies spoil the party? I muse on this question ...
Back in November 2011the new IMF Managing Director Christine Lagarde said the world
economy is in a “dangerous phase,” and US Treasury Secretary Geithner said that Europe needs to "move more
quickly and with more force behind it.” Since then little has been accomplished in 14 European Union meetings and the credit crisis has only deepened.
On
January 5th Bloomberg Financial reported that the European Central Bank
made an unprecedented cash injection to ease borrowing costs for Italy,
Spain and Belgium, compensating for the lack of a solution to the debt
crisis and the risk of recession. (I question whether the word recession
is strong enough. I think they fear worse.) European leaders have
failed to come up with what German Chancellor Angela Merkel described as
a “big-bang” solution to the crisis, so the ECB did the only thing in
could do to prevent Europe's mounting crisis from imploding. But the
ECB did not solve the problem, they only postponed the inevitable a
little while longer.
While there is no physical limit to how much
money the ECB, or the Federal Reserve, can print, eventually market
forces will come to bear and to draw a line on what the world's
financial markets will accept. The trillion dollar question is where and
when is that line.
We may get a preview or foreshadowing sooner
than latter. Standard & Poor’s said Dec. 15 that it was reviewing
the credit ratings of 15 euro nations for a possible downgrade,
including AAA rated Germany and France, citing “systemic stress in the
euro zone.”. It is more than conceivable that they will indicate what
everyone already knows which is that there is no visible or sensible way
that many of the Euro countries can pay back the debt they have been
rapidly accumulating and that if the ECB where to stop printing money
and buying their bonds they would have to default. A meaningful move
down by the rating agencies would ostensibly be saying that the
countries are insolvent.
One might say, "so what?" since for
all practical purposes they have been insolvent and anyone with any
sense already knows it. But the difference here is that the rating
agencies have the power to make it official! A damaging multiple notch
reduction would make it virtually impossible for those countries to sell
their bonds, making the ECB, assuming the US Federal Reserve stands
down, the only way for them to fund their governments and largely their
economies. Thus worsening the reality of the crisis, and setting up the
real likelihood of a ratings death spiral as rating agencies do another
series of rating reductions until many Euro counties are lowered to junk
status, significantly devaluing the Euro currency in the process, and
drawing France and Germany fully into the mess. At that point, if not
sooner, the whole party is over for the Euro. Or is it?
One might
think that forcing write-downs of the debt (haircuts) on bondholders is
the answer, but it isn't. By definition that has to constitute default
and trigger insurance claims. That just deepens the crisis. There
will not not be a credible solution in sight until Chancellor Merkel
gets what she wants and the world needs to see, which is serious fiscal
austerity by virtually every insolvent Euro country. Countries like
Italy, Spain, and Belgium will have to cut beyond the point of
discomfort. Beyond the point that their unions will stand for. Beyond
the point of hurting their national pride. They will have to cut into
the bone! They will have to chop off limbs! I'm talking the sale of
national treasures! Things and institutions that were once considered
sacred will be on the block for cuts or sale until these countries can
prove to the world that they can sustain their government's funding
requirements without depending permanently on the ECB.
This is
not to say that the ECB's job is done. Oh no! But instead of buying
these nation's debt they will be funding their liquidation as well as
finding creative mechanisms for funding growth. Who's to say the ECB
can't concoct some indirect way to fund the purchase of equities in new
offerings for start-up or growing businesses or why couldn't they buy a
priceless piece of artwork owned by a government and put it back on
display in the same location where it is presently located? Radical
times call for radical actions! And I except the Federal Reserve to be
as creative as any body at finding ways to stir the phoenix from the
ashes.
All countries may not go along with the draconian steps
that I am describing. Those that refuse will for all intents &
purposes be kissing their Euros goodbye. What will be left is the
"haves & the have nots." Those that have have euros and those that
have defaulted on their obligations and opted to revert back to their
original currency. Who's the better? There's too many variables for me
to form a prediction at this time.
But eventually, the counties
that take the necessary austerity actions, voluntarily or by market
force, will get to a point where they can fund themselves. And provided
their populations and civilization can handle the turmoil of so much
change and sacrifice they will reach a new equilibrium. (The so called
new "new normal" that Pimco co-chair El-Erian declared will have to wait
a bit.) Signs of new life taking hold will be evidenced in the same
way the death of the old was announced -- we'll know we've survived when
the ratings agencies collectively raise the ratings back up.
It
must be very daunting and scary for those agency committees today!
Imagine, knowing your actions can literally trigger events that will
reshape the world today, but NOT knowing where it will all lead. (If
there is one thing that truly does scare me is how such a deep crisis
as I am describing has a way of bringing out the worst, along with best,
in people.)
Efforts to reach an orderly resolution between bold holders and Greece authorities seem dire. The only thing keeping bond holders from calling in their insurance claims is the contagion effect on their other holdings, which also threaten both national and bank solvency, and the Union itself.
It seems to me the only hopeful course is an unprecedented and synchronized combination of massive fiscal austerity actions by insolvent Euro nations, enormous monetary stimulus from the ECB, and aggressive pro-growth policies in Europe, the USA, and emerging nations around the world.
Back in 2009 when America was in the throws of its own financial crisis,
Federal Reserve Chairman Ben Bernanke made the point that the biggest concern he had was whether
or not America had the "political will" to deal with the challenge. When it comes to the Euro crisis, Chancellor Merkel has proven that she has great political will, but she can't do it alone, and I seriously question whether her German and Euro colleagues have the political will to brake the pattern of this Euro crisis BEFORE it brakes them and us?! And, the ratings agencies are saying the time to do so has nearly run out!!