Παρασκευή, 18 Νοεμβρίου 2011

The Euro Zone's Deadly Domino Effect



πηγή: spiegel
walter munchau

Remember Henry Kissinger's domino theory? The former US secretary of state feared that the neighbors of a state that was under the control of the Soviet Union would also fall into Moscow's sphere of influence. Today, the theory that used to be applied to communism can be seen on the bond markets of Europe. The sovereign bonds of more and more euro-zone countries are coming under attack. Soon, one country after another might topple.
The reason for this desperate situation is the catastrophic crisis management in Europe. The German statesman Otto von Bismarck once said that only fools learned from their own mistakes -- he preferred to learn from the mistakes of others. At the moment, no politician or adviser in Europe has bothered to learn the lessons of the Argentine or Asian debt crises. Indeed, in Europe, they aren't even learning from their own mistakes.

The public chatter about a possible Greek exit from the euro zone is one example of how they are repeating their mistakes. In the summer, the impact of the participation of private investors in a debt restructuring was recklessly underestimated. Now, they are underestimating the consequences of Greece's leaving the common currency.

Broken Promises
Back in March, European leaders promised that all investments in Greek government bonds would be guaranteed until 2013. But, in July, they went ahead and negotiated the involvement of private investors in a Greek debt restructuring. The economic situation in the country had worsened, and the political mood in Germany had shifted. At the time, the European Central Bank (ECB) urged caution. It argued that once you go down that road, you make investors nervous. As a compromise, euro-zone leaders agreed on the following formula: The terms of the participation of private investors in a so-called debt "haircut" would not be renegotiated, and it would certainly not be extended to other states.
In the following weeks, exactly what the ECB had feared happened. The interest rates on 10-year Italian bonds rose to 5 percent. And there was worse to come. In July, European leaders broke their promises from March. In October, they broke their promises from July. The participation of private investors would now be much higher, they decided.
Following that summit, investors came to the logical conclusion that politicians have basically been lying at euro summits. They surmised that, if the economic situation in Greece and the political mood in Germany changed, then the owners of Portuguese and Italian sovereign bonds would also be asked to contribute. In the meantime, even normal individuals are now withdrawing their savings from banks across southern Europe.
Exit Scenarios
In recent days, the crisis has expanded to France. The difference in interest rates between French sovereign bonds and benchmark German bonds -- the so-called spread -- has risen to record levels. France could soon be in same position that Italy is in today. Meanwhile, interest rates on Spanish 10-year bonds have hit their highest level since 1997. European bond markets are experiencing the domino effect.
Now ask yourself the following question: What will most likely happen if Greece leaves the euro zone? The answer is clear: We will see a domino effect in that respect, too. SPIEGEL reported earlier this week that the German Finance Ministry has come up with a number of scenarios to simulate what would happen were that to transpire. Those models make it clear to me that the German government still doesn't understand the mechanisms and momentum of this crisis.
The main problem of a Greek exit from the euro zone is not necessarily the direct impact on banks. I believe our government when they say that they would be able to get that under control. The real problem is the next domino. The crisis will spread unchecked to Italy. If Greece leaves the euro zone, then owners of Greek bonds will lose their entire investment. At best, the Greeks would pay them back a small part of their investment -- in almost worthless drachmas.
Crises Must Be Solved Quickly and Decisively
So what kind of investor in his or her right mind would purchase Portuguese, Spanish or Italian sovereign bonds in this kind of situation? Not even a yield of 7 percent can make up for all the risk that Italy won't be able to pay back its debt. As things now stand, Italy's debt accounts for 120 percent of its annual GDP, growth is close to zero and the country is currently slipping into a deep recession. In fact, it's a matter of mathematical inevitability that Italy won't be able to service its loans if interest rates on its sovereign debt don't fall. Granted, there have to be reforms. But reforms don't resolve an acute debt crisis. We've already learned that lesson from other crises.
In the future, we will be forced to adjust our Greece program to a continuously worsening reality. At some point, this strategy of lying to ourselves will end in catastrophe: Greece's exit from the euro zone. There's no plan in place for such an eventuality. No one knows how a protective surge wall can be erected around the rest of the euro zone. If we are not sufficiently prepared, then we'll suddenly discover that Portugal is the next domino to fall.
In Germany, these matters will continue to be debated, commented upon and processed. Meanwhile the dominos will continue toppling. And that's the point when there will no longer be any alternative in Germany but to accept the unpopular euro bonds as well as the much more unpopular price guarantees via the ECB.
Indeed, one of the most important lessons to be drawn from the policies that Argentina followed during its currency crisis at the turn of the millennium is that -- one way or another -- crises have to be solved early and decisively. The longer one waits, the more expensive things get for everyone involved. But this lesson doesn't seem to be one that has been internalized by the German government, the European Union or the ECB.
In fact, Chancellor Merkel and her colleagues only take action when the markets have already started to panic. When that happens, all of the entreaties and pledges don't help a bit.
And, once the last domino falls, we can all kiss the euro goodbye.

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