European hieroglyphics

You can find anything on the Internet, even a site that translates English into hieroglyphics.  According to Quizland.com, the tablet at left says “We do not understand financial markets”, and it could be the motto of the Eurozone leaders.

In its rejection of Anglo-saxon free markets, Europe has been under the delusion that these can be willed away or bent to the wishes of political and other leaders.  One can recall Mr. Trichet, then president of the European Central Bank, flatly stating that Greece would not restructure its sovereign debt, and his “ruling” being repeated by a large chorus of European politicians; or President Sarkozy, after each summit with Chancellor Merkel, declaring that the debt problems had been solved by the negotiation of a new memorandum of understanding and that markets would thus have to fall in line.

When this didn’t work, several futile ideas were proposed, like creating local credit rating agencies (presumably under close scrutiny from eurozone governments) to write credible reports yet refrain from calling for unwanted debt downgrades.  As pressure kept mounting, intricate rescue plans were offered, which had the principal merit of multiplying euros earmarked for intervention funds as if they were fish and loaves of bread.

This state of mind isn’t unique to politicians and bureaucrats; it is shared by bankers as well.  For years, the top banks of Europe have operated under the guidance and protection of their governments.  In so doing, they ended up believing the messages delivered to the “gullible masses”, that the state always gets it way, and that, by staying in the governmental wake, so would they.  This led many banks to rely excessively on wholesale funding, to under-reserve, to feel comfortable with lopsided loans-to-deposits ratios and to be undercapitalized. 

Eurozone banks believed that they could bluff their way through the current crisis.  Indeed, only one, Unicredito from Italy, had the courage to raise $10 billion of fresh capital at a huge discount to market price.  But markets quickly wised up, forcing a liquidity crisis at the same time as a solvency one was worsening.  By then, the most exposed Spanish banks couldn’t access the markets.

The solution to the latest Iberic crisis is true to form, so far: opaque, uncertain as to timing and bound to close markets further.  Opaque because such terms as interest rate, final maturity and conditions have not been disclosed; uncertain as it is not clear whether Spain has formally asked for a rescue package for its banks and what the trigger for recapitalization would be; finally, the recapitalization will be funded by loans to a Spanish agency, thereby increasing that country’s debt burden, and will be chanelled through the ESM to assure seniority over private creditors; this will make future access to the markets that much more difficult. 

The causes of Greece and Spain’s financial troubles are different, but in both cases the eurozone rescue packages, while clearly designed to reduce risks for the institutions that provide help, in effect raise them.  Greece private creditors were handed a 75% effective loss (which has risen to 80% since) to insulate official creditors, and official creditors gained preferred status on the money they lent to Greece.  The private creditors’ loss is greater than the 75% one forced a decade ago by Argentina which was (rightly) characterized as an effective spoliation. Greece abandonned a very reasonable €50 billion privatization program.  Sovereign  bond contracts were retroactively amended by the state.  Net net, financial markets have no rational motivation to return to Greece any time soon and eurozone states are now ‘it”.

In Spain, the sovereign debt will be raised by some 12% to fund the bank rescue, it is not clear what reforms will be required of the recipients, whether the bad banks will be liquidated and how much further help will be needed by the government.  If the bank rescue loans rank ahead of regular sovereign bonds, it is pretty clear that any holder of Spanish, or maybe even Italian, government bonds better sell them in a hurry.  This will leave the eurozone countries to hold the bag, except that their bag of tricks will soon be too small.  At the end of the day, a lack of capital in Spanish banks was remedied with an increase in debts of the Spanish state.

As the eurozone dithers, risks of implosion are rising.  When one country after the other receives financial assistance, it drops out from the pool that will fund the next sovereign borrower in need.  Clearly, Germany, being the last one in line, is on the hook to fund everybody unless the process is changed. 

Spain is make-or-break for the eurozone.  If it fails, Italy gets into the line of fire and, in my opinion, Germany leaves the eurozone because it would have neither the means nor the desire to mortgage its future to save everybody in the eurozone.

What can be done?  If I were head of government in the eurozone, I would try to prepare for the day when Germany refuses to help out.  This means controlling public spending in a way that is politically acceptable: means testing programs, reducing civil servant headcount through attrition and, inevitably, across the board spending cuts as well as some tax increases.  More controversial would be labor laws reform to foster hiring of the young and, yes, pension reform.  These last two issues are hazardous to a president job security, but the payoff is worth a try.  Mr. Hollande has demanded that the CEOs of public sector companies limit their salaries to 20 times that of their employees and that the CEOs in the private sector likewise restrain themselves.  This may be nothing more than demagoguery, or it may be the necessary first step to ask everybody to share in the pain. 

Finally, the deleveraging pain could be alleviated by privatizing public assets.  According to Mr. Stark, ex-board member of the ECB, Greece has over €300 billion in public assets it could sell.  It was supposed to sell €50 billion.  Spain, Italy and France have much more to sell.  Markets can be of great use in gathering funds and setting fair prices for public assets.  Argentina, Brazil, Chile and the UK did it not so many years ago.  It could and should be done today. 

Perhaps another reason why I think that it is crucial that European countries accelerate reforms on their own NOW is that I have real doubts about the future of the eurozone: I am pretty sure that if it survives it will be as a reduced group of more homogeneous countries. Even then, I wonder if ”deep integration is possible”. 

Are most of the eurozone inhabitants willing to let Brussels bureaucrats run their lives?

Are the French willing to align their labor laws and retirement age and benefits on those of Germany?


Short of a full federation US-style, how much, or little, integration do you need to run a common currency alliance on a sustainable basis?  The truth is that we don’t know. 

There is a big world out there, and if it is that big it is thanks to free markets.  Europe's mistake has been to be built to keep the barbarians out, so to speak.  Relatively less effort was dedicated to pool resources and compete on the world stage.  If the eurozone is to succeed, it needs to be redesigned to make a core Europe as competitive as it can be on the world stage.

By the way, the Tweety Bird standing over the English lawn means “no” in hieroglyphics.