Catharsis and the Fischer smile
Catharsis, the emotional purification in Greek drama or the logical conclusion at the end of a play. It seems to me we are nearing such a point in the euro-zone where conflicting parties - now in full collision course in a super game of chicken - will be blessed with catharsis one way or the other. What is at stake ?
In previous postings earlier this month, we we pondered on the dramatic evolution in Spain with banking and public finance now really being pushed into a tight corner. In between days, we read some horrific stories about the regions of Catalunya and Valencia. In the latter case, the Greek drama is complete in view of the decadent features now prominently present : some years ago, abundant billions of euros were spent on hosting a F1 event and an opera/museum of arts mega construction designed by Calatrava. Today, austerity has hit the education department in the sense schools no longer have the money to buy heating fuel, to provide children with educational material and kindly ask students to bring along their own toilet paper.
So the current political and economic/financial situation is reaching boiling temperature: Irish referendum as we speak, Greek elections on Grexit/Troika renegotiations in a fortnight and Spain facing near term bankruptcy. Are there any dramatic solutions in stock and if so, what are the odds they will be favored by an unanimous real-politik ?
1) Unconditional 100% joint eurobonds issuance wrt sovereign debt : not really the best wildcard to play and with not much appetite either in several countries. From a fundamental point of view, joint-eurobonds are a natural endpoint once a monetary union has successfully developed, meaning convergence in all corners of the economy. So a logical endpoint is something entirely different from an intermediate emergency lifeline (short term) measure. Under present circumstances, my guess is that this is not a realistic political scenario. And on the market credibility of this scheme I have my doubts as well. But once it has been pulled out of the magician's hat, this white rabbit could have far reaching market consequences in the short term.
2) Bring in the EFSF/EFSM banking bazooka : This is now on top of Madrid's agenda in view of the Bankia debacle and most likely other banking/developer corpses hanging in the cupboard. Spain's banking sector has now been completely cut off from private sector funding which basically means that Spain is now the main strain on the European system of central banks (280 bio EUR in the red for Target2 with Germany being creditor for 650 bio EUR). Some estimates on recapitalization requirements for Spanish banks are ranging from 200 bio to 350 bio EUR, depending on how serious you judge future non performing loans on Spanish balance sheets. EFSF/EFSM however was not designed to help out private sector banks and if this should be the road to follow, we face 2 main obstacles : a legal one of modification ratification and a public one, being banks being bailed out once again by the European taxpayer. It might however stand a chance because somehow the banking sector problems need to be addressed in the single currency zone if holding the monetary union construction together is still the main priority. As stated before, the banking and sovereign debt crisis are Siamese twin partners in crime and have to be addressed simultaneously.
3) The German compromise - redemption Fund : This is an idea stemming from the panel of 5 German wise men & women late last year. It basically involves the following ingredients. Primo, we would have a mutualistion of sovereign euro debt (jointly covered) above the 60% critical threshold, backed by EMU member gold reserves worth some 2,300 bio EUR. But secundo, it is not unconditional, to the extent that those who have a lot of work to do in reducing their debt towards 60%, will have to comply with strict rules on fiscal adjustments (fiscal compact in fact is a predecessor here, institutionalizing debt brakes in various national states etc). There are of course some problems along the way :
3.1. The fact we would call it a temporary redemption fund is a euphemism to say the least. It would probably involve a long and winding road of harsh discipline over a time frame of 20 to 25 years.
3.2. The panel's study also reflects the weakness in terms of assumptions which could have an impact on the trajectory in terms of time (25 years) and required efforts (primary surplus) : The required primary surplus for Italy to achieve this objective would be 4.2% of GDP for each year in the redemption period, assuming that nominal GDP grows at 3% per annum, the new Fund were to confront refinancing cost of 4% and the interest rate Italy has to pay is 5% for the remaining debt. Achieving a primary surplus of 4.2% of GDP over a prolonged period of time will require sustained fiscal discipline. However, the scheme should still be attractive to Italy despite the strict conditions attached to participation, since the joint and several liabilities of the Fund ensure lower refinancing cost. The primary surplus required for Italy to achieve the same reduction in debt without the ERF scheme (assuming an interest rate of 7%) would initially be more than 8% of GDP.
So is this third solution credible and most of all feasible ? Possibly but again, not much of an alternative is on hand f the priority is to keep the construction afloat under its present composition. Another alternative is unlimited refinancing by the ECB (dead end street). The panel's conclusion sounds " Certainly, the European Redemption Pact is a grand scheme which requires bold action and a long term commitment to the Eurozone. In return, it offers the promise of a definitive solution to the crisis by redeeming debt rather than piling on new debt". And to add the comments of a latest Credit Suisse analysis on the subject :"Mutualisation might work because in aggregate Europe has lower government debt and fiscal deficits than the majority of the developed world (US, UK, Japan). It is therefore not a problem of the amount of debt but rather of the distribution of debt"
Crucial piece on the current chess board remains Queen Angela. And she is facing similar choices on the domestic front where a majority of German Länder (CDU no longer in control) are now requesting federal guarantees when it comes to issuing new debt in order to lower regional funding cost (white raven here of course is the state of Bavaria). And Merkel needs the opposition's assistance for pushing through the legislation concerning the fiscal compact. The issue will be restudied in Germany as promised by Angela and be discussed at the upcoming EU top summit. So things are moving, key question remains in which both pragmatic and credible direction.
Sometimes chess can help. And various famous grandmaster games can be mind blowing and inspiring. Michael Tal was a scarce example of a Draufgänger, surprising his opponent with highly speculative sacrifices and winning the game in the end with not much of his own pieces left on the board. A fine example of a reversal of fortune can be found with Polgar-Short (NY 1994) where young Judith could have resigned after 10 moves but spectacularly wins the game 15 moves later. But I think Bobby Fischer might be inspiring in these days of suffering. The next game Bobby played at age 14 is truly a gem : when the black squared bishops are exchanged, Bobby makes a daring rook move while at the same time being threatened by mate on the back row. And to finish his combination, he makes an incredible pseudo-queen sacrifice with discovered checks by which his opponent is completely paralyzed. In-cre-di-bi-le ! Enjoy the mysterious Mona Lisa smile and the last 5 minutes of this game. And let's hope our grand leaders can draw some inspiration out of the games from Bobby, Micha Tal, or Magnus Carlssen (youngest chess grandmaster ever and rising star, the Norwegian Mozart of chess).