European Shadow-play : Games without frontiers
On 11/03, the Euro-zone, instigated by the German/French axis, put the following new game-play on the table :
1) More benign restructuring conditions for Greek debt, "no" to a similar request for Ireland.
2) An expansion of the EFSF rescue mechanism fund to an effective 440 bio eur, this through an increase of the guarantees provided by AAA countries.
3) EFSF support is conditional and subject to "stability tests". Countries which have no longer access to markets can also apply for help, enabling EFSF to buyprimaryissues (no secundary).
4) New bond emissions should also carry so-called collective action clauses which make it more easier in the future to retsructure/reschedule the debt should this become necessary.
On point no 1, 2 reflexions come to mind : A very strange softening of Greek conditions in combination with a "no" to compasion requests from Ireland. It is strange because from the start onwards, the Greek government has breached every Maastricht I rule while Ireland was until 2008 an excellent pupil. The Irish simply have to accelerate bank asset liquidation with no positive incentive, unless they give up their 12.5% corporate taxation regime. Apparently dura lex sed lex. On the same liquidation issue, another reflexion. In the original IMF rescue proposal, Greece had to liquidate EUR 5 bio in government assets through privatization. In the current proposition, they have to find a 10 fold amount or EUR 50 bio. This is an equivalent of 21% of Greek GDP, a very hard task to find unless there is an island for sale.
On point no 2, let's have the numbers speak for themselves. Because of overcollateralization, the original EUR 440 bio was restricted to an effective EUR 255 bio. Under the new blue-print, the EUR 60 bio EFSM is stil there, added with EUR 412 bio which requires overcollateralization and EUR 236 bio coming from the IMF (previously EUR 157 bio). The total available has been lifted from EUR 472 bio to EUR 708 bio (USD 1 trillion). These are big numbers and AAA countries are supposed to double their guarantees. In the case of Germany, it would involve a EUR 234 bio guarantee or almost 10% of GDP. Not easy to sell at home. And even less easy to sell in Finland where elections are within a fortnight with 'True Fins' imposing their veto on this to the election program of current ruling parties. The Fins might become a major obstacle over the coming 48 hours on this issue. Maybe Erkii Liikanen succeeding JC Trichet could convince the Fins. And it would most likely be a viable solution for Germany – next to Yves Mersch -in view of Mario “Goldman” Draghi. Obstacle here is that Olli Rehn is currently EU Commissioner for economic and monetary affairs.
On point no3 or the conditional support clause for helping states in need. Here Maastricht II is even tougher than Maastricht I at German request. However, it remains to be seen how Maastricht II solves the "moral hazard" problem Maastricht I never solved. How to legally enforce punitive action om member states, something Maastricht I never achieved in the case of Germany & France (2005) or Greece ? Thesustainability conditionsin the case of Greece - bringing the country back to normal debt levels in 2040 - are based upon 3 assumptions : an indefinite5.5% primary budget surplus, a real GDP growth of 3.5% and an interest rate at most of 5.5%. On all these 3 assumptions, big question marks should be raised. It's not realistic and if enforced by more of the same austerity measures, it could invoke some unforseen political revolutions. And these shaky assumptions - most likely accompanied by "tough talk" but "soft conditions" in case of future urgency -will put a future burden on European tax payers. And with clauses on restructering included, it will most likely frighten private investors from future post 2013 primary bond auctions (that is, if these public auctions should see the light again).
Which brings us to the final point : Debt restructuring is unavoidable and everything is put into place to make this possible in a couple of years time. It buys also some time for the ECB to get rid of the current eur 77 bio of bonds on their balance sheet. And it buys time for commercial banks to shelter their balance sheets as well. And as far as markets are concerned and looking at 2 and 5 government bond yields of Greece, Ireland and Portugal, the scenario seems likely.
Who will buy this future new debt after 2013 ? We already posted some comments on this one (http://www.econoshock.be/2011/the-good-the-bad-and-the/) but it is clear that the new rules of engagement are as follows : the Good pay up front in EFSF and pay extra on their own emissions ; the Bad have no longer public primary emissions because not enough buyers will show up ; so the Bad bonds will have to be shored up in primary auctions by the supra-national Ugly (primarily financed by the Good). Briefly, EFSF will be "AAA" Collateralized Debt Obligation.
Mind you, this is not so horrific in view of what is happening in the US. Here we also have a AAA CDO when looking on how credit default swaps are currently pricing Illinois, New Jersey, Nevada and California (the latter size Italy, 13% of US GDP). And may be if the US is not structurally defaulting, they are currently making a great effort to inflate their way out. If after QE II, no QE III/IV sees the light, caveat emptor. In fact, this is basically the same as luring investors into a "buy opportunity" but at the same time selling them structural default : if you buy a 10y @ 3% and 10y rates move to 5% or more, your investment will register double digit "haircut" loss on the spot.
Hans plays with Lotte, Lotte plays with Jane
Jane plays with Willi, Willi is happy again
Suki plays with Leo, Sacha plays with Britt
Adolf builds a bonfire, Enrico plays with it
-Whistling tunes we hid in the dunes by the seaside
-Whistling tunes we're kissing baboons in the jungle
It's a knockout
If looks could kill, they probably will
In games without frontiers-war without tears
Games without frontiers-war without tears