"Mrs. Charles Benning sweeping steps of shack in Shantytown. Spencer, Iowa"
Ilargi: A double header today for your weekend reading. First the depressing spectacle in Europe, where Slovenia, Austria and Spain have -each in their own way- been added to the list of countries at risk of -further- downgrades, while France has received a temporary break, sort of a fleeting breather. Second, Ashvin introduces Nathan Carey from Ontario who writes about Hardwick, VT, and shines a light on the successful efforts at the economic revitalization of the community.
Ilargi: I'm convinced it’s not so much that it's hard to understand; instead, it's hard to accept. Still, for most people that's enough reason to not understand.
It might therefore be a good moment to reiterate what we've said often before at The Automatic Earth: the financial system as we know it can not be saved. It doesn't matter whether "official institutions" nominate 30 banks as being too big to fail, or 300. It is inevitable that the enormous amounts of debt accumulated in a relatively and amazingly short period of time must be serviced. Pay offs, write downs, defaults, bankruptcies. They're cast in stone. It's too late, too big to fail or not.
Just as it is too late for the Eurozone. Tons of "experts" clamor for Europe to move closer together, and form for instance a full fiscal, if not political union. But it's way too late for that. The interests at this point in time have simply become too divergent.
There now seem to be talks underway to form a strong Euro core group. Ironically, these talks are led by France. Ironic, because France is the only country that really stands to benefit from such a core group. That is, if it's allowed to be a member. Which is highly questionable.
French President Nicolas Sarkozy is witnessing the fall of Italian PM Berlusconi with sweaty palms. He has ample reason, says also Henry Samuel in the Telegraph:
'France will be the next to crumble', warns Gordon BrownFrance risks becoming the next victim of the sovereign-debt crisis "in the coming weeks", Gordon Brown, the former prime minister, has warned.
Mr Brown’s prediction came as the difference between French borrowing costs and those of Germany hit record levels. EU leaders urged France to draw up further austerity measures to meet its deficit reduction targets, amid fears the eurozone’s second biggest economy could crumble if Italy’s debt crisis spirals out of control.
Mr Brown, speaking in Moscow, said: "France is in danger of being picked off by the markets in the coming weeks and months." [..]
"Let’s not have any illusions," said Jacques Attali, a former adviser to president François Mitterrand and head of the European Bank of Reconstruction and Development. "On the markets French debt has already lost its triple-A status."
One Elysée Palace official told Le Monde newspaper: "If Nicolas Sarkozy loses our triple-A, he is dead."[..]
Ilargi: While I have no desire to address Gordon Brown's level of credibility here, if we assume that the last statement is indeed true, then Sarkozy's career is over. Because there is no way France will keep its AAA rating. The only way that would be possible is if Germany (and/or the US, China) would guarantee anything French that's not bolted down. Not going to happen.
France's reality is clearly visible in this Société Générale graph, which I posted earlier this week:
Even if you would give Paris some benefit of the doubt, and assume that it can somehow handle the situation for an X amount of weeks/months/years longer, a country with liabilities running at 549% of GDP does not merit an AAA rating. No more than any CDO squared filled with toxic loans does. Which is why the US at 541% has already been downgraded.
This is a truth that every ratings agency will need to face up to at one point. Thursday's erroneous S&P report of a French downgrade could well be a gift from heaven for Sarkozy. After all, he gets the opportunity to angrily deny it all across the media, and plus he knows S&P will hesitate when it actually does want to downgrade the country. But it still must down the line.
France wants a core Euro group comprised of Germany, the Netherlands, Finland, Austria and itself. Not going to happen. If and/or when it came to a break-up, the other four would rather see France lead the "poor", mostly Latin group, for reasons the graph above spells out loud and clear. And that's a role France will not accept, ever.
Moreover, Austria also runs the risk of a downgrade, over its exposure to Italy and Eastern Europe. In other words, a rich core group would consist of Germany, the Netherlands and Finland. But the Netherlands has seen a major housing bubble that has yet to pop. Once it does, and it must, we'll be left with just Germany and Finland. And why would the Finns choose that over independence?
Every single scenario that has Europe either come closer together or break up in an orderly fashion is full of holes. What's left, then, is chaos. The rise to power of Papademos in Greece and Monti in Italy will not change this. What it will do is put a much harder squeeze on the people of the countries.
There should be mass protest against the developments in the streets of Athens and Rome, but people have not yet processed what is happening. When they do, it will in all likelihood be too late. Monti and Papademos are there to execute a short lived "transition" job, and to then vanish.
To sign a whole bunch of things into law which facilitate yet another round of bailouts and other support measures for their financial industries, and which will cause enormous hardship for the people (you ain't seen nothing yet). Afterwards, someone else can take over and claim it's not his/her fault.
We've come to a point where there is really only one major choice left to make. It's either to support the financial industry, which is irrevocably linked to both the financial and the political system, or to support the people. The fairy tale we've consistently been fed that they're one and the same, that saving the banks will save the people, should have been laughed away and wiped off the table long ago. But it’s 11-11-'11, and the fairy tale's still there. It's big fat lie that serves only to take hold of what scarce money you have left.
We find ourselves in a full blown credit crunch. Chris Whalen may call it a "slow motion" credit crunch, but that, however tempting the idea, is at best partly true. The reason why lies in the trillions in future taxpayer liabilities that governments have pushed into the banking sector. Without those trillions, hardly any lending would be taking place. And with the trillions, the whole house is still coming down anyway, no matter all the talk about a recovery.
It is slow motion only when you look at the stock markets, when you see the world through the eyes of an investor; in the streets of Athens or Detroit, for instance, there’s nothing slow motion about it. Not where the budget cuts and austerity measures are implemented that pay for bailing out banks silently drowning in as yet unrecognized but soon to be revealed losses.
Still, whether fast or slow, a giant credit crunch driven by debt deflation is irrevocably heading our way. Trying to stop it is entirely useless; using what scarce future wealth there will be to execute the futile attempt at doing so is extremely harmful. The world needs something better than finance industry henchmen like Papademos and Monti if we wish to minimize the upcoming suffering of the 99%.
Ashvin Pandurangi: As the financial and equity markets continue to gyrate back and forth with unprecedented volatility in response to the ongoing implosion of the European sovereign debt ponzi bubble, what better time to purge these daily doses of anxiety, confusion and frustration from our minds, and focus instead on what those of us who live in rural communities can start doing right now to revitalize those communities, their residents and surrounding areas.
Nathan Carey, the second winner of TAE Community’s "Diamonds in the Rough" project, has provided us with just that opportunity in the following article, which explores the ways in which small-scale agriculture can be reinvented in small towns or rural areas, bringing economic stability and vitality back to those communities. He shares his own personal experiences with this issue, and also gives us a specific example of where such an effort has been successfully undertaken so far, in the town of Hardwick, Vermont.
But first, in keeping with the growing tradition of the TAE Community’s "Diamonds" project, I would like to give a warm mention to the three Diamonds which did not win a majority of votes in the last poll, but which were all fascinating and deserving of further contemplation by our community. Here are those three ideas, in the order of the votes they received (highest to lowest), along with a few reference links to information and explanations for anyone who is interested in exploring them further.
1. The American Homestead Act of 2012, by Richard Elder [Basic Outline of the Idea]
2. Local Complimentary Currency Model, by Aki Järvinen [Detailed Overview of the Idea], [Video Presentations (in Finnish with English subtitles)]
3. State-Owned Grain and Flour Mills, by Tom Gibbs [Link to History of ND Mills]
And, now, on to today’s main course, which is a generous portion that has been prepared and served to us by Nathan Carey. Bon appetit!
The Historical Trade-Off Between Efficiency and Resiliency
For several generations people have been tearing up their country roots and planting themselves in urban centers. It is one of the strongest and most ubiquitous migrations of this century across the world - the migration from rural areas to urban cities. In fact, "rural areas" have simply become the space between departure and arrival. They’re just exits off of the freeway that you have no reason to take. The reason for leaving is quite clear, though.
Starved of jobs and opportunities for socioeconomic "mobility", our rural towns are dying painfully slow deaths. This process is evident traveling through almost any small town two hours away from any urban center in North America. We see empty storefronts with yellowing "For Rent" signs, empty cracked streets with faded paint, empty crumbling grain silos and empty tilting barns. In the last few years, poverty has only gotten worse in America, and especially the rural portions that are largely ignored.
But, as our economy and the society it supports simplifies from the myriad of pressures bearing down on it, human populations will have to leave their energy and import hungry cities to once again fill the ‘empty’ spaces with life and labor. I believe there's a great way to revitalize and prepare these empty places now, while we still have the means to maneuver. Small-scale, resilient agriculture is a way to transform the rural landscape into the kind of place people want to visit and live in.
The starkness of these places became viscerally evident to me when I moved from my boyhood suburbs of Toronto to rural Ontario. My wife and I bought fifty acres of fertile soil that we fostered into a farm business. After many years of interning, living in trailers and seeking out farming know-how, we felt we were finally up for the challenge of running our own farm business and got started.
Our vision of agriculture is small and diversified. We run a winter vegetable CSA where our members pay us in advance for vegetables that we dole out throughout the long Ontario winter. We also raise and sell various kinds of meat: lamb, pork, chicken, turkey and soon, beef. Neither of us come from farm backgrounds and we represent many in the ‘new farmer’ movement – young, educated, practical and willing to put the hard work in to transform the ideas floating around in our brains into reality.
The kind of farming we are practicing is based on resiliency. It is in direct contrast to industrial farming whose underlying strategy is efficiency. We don't plant one type of crop; we plant thirty. We don't have one income stream; we have several – including teaching and telecommuting employment from Toronto. We don't have one customer; as many wholesale producers do, we have hundreds.
But while we are resilient we also suffer some lack of efficiency. Our larger, more conventional neighbors can take an acre and turn it from sod to seed bed in less than an hour. It would take us a full ten hour day to do the same with our small walk-behind tractor. I think it's helpful to see these two strategies, resiliency and efficiency, as opposing points on a continuum of system building. To be too far towards one or the other is detrimental to the system's health.
Too efficient and you "find the straightest road to hell" (a quote from James H. Kunstler via Nicole Foss). If you are mired in resiliency, then you'll never really get anything accomplished. Resiliency is supple and adaptive. Efficiency is hard and effective. Too supple and you have no form. Too hard, though, and you become brittle and break. Our modern economy which has made a god of efficiency is ultra-efficient and ultra-brittle.
Small-scale agriculture is attempting to move back to the middle but hedging much closer to resiliency than efficiency – a hedge based on our uncertain future. What does resiliency look like? On our farm we have five different types of animals that all produce manure. This assures we are not dependent on outside sources for the garden’s fertility needs. We have been careful to scale our operation to be largely manageable by hand or with small tools.
This precaution assures that, while we can and do use diesel driven implements to help us, we are not completely reliant on them. Your average CSA market garden is going to have fifty different crops usually with a few varieties of each: 3 varieties of carrot, 5 squash, 8 tomato varieties, etc. This variety means that a single disease doesn’t wipe out a whole season’s worth of work. It may only wipe out one row. There must be a balance with efficiency though.
If local food systems are to feed whole regions, then they must also be of a scale to accomplish that. This balance is going to take many years and many kinds of farming to discover. The rural landscape is far ahead of the global economic turmoil we see crashing in slow-motion around us. It found it's 'bottom' and has been living there a long time. Most people living in small towns didn't go into debt to flip a 'fixer upper' on the housing market.
Maybe that’s because there was no housing market where they were, and there still isn't. Or maybe they can't get credit because of their low wage or lack of employment. The story of most rural towns is the same: its bottom arrived at the end of a short, straight road paved by a single, large employer. Maybe it was a textile-mill, a mining outfit, a car manufacturer, a power-station.
This large employer came, created jobs, created industry, created a community around them and then, just when life was being taken for granted, it all fell apart. Maybe a large company bought the local company out and moved it off-shore. Maybe the resources being extracted were no longer worth extracting. Maybe government regulation drove costs beyond the breaking point.
The Basic Drivers Underlying Small-Scale Agriculture
Whatever the specific details, most rural areas seem to have charted a familiar story all over the continent. I think it can be said that formerly resilient rural economies swung hard towards efficiency and then broke at an unexpected shock. Really, it's the story of the twentieth century writ small on town after town. So why should small-scale agriculture become the hero of this developing story about a North American Continent centered on local communities? That’s a big question to answer, but we can start with a few of the following reasons.
1. Filling a Non-Negotiable Gap - We must anticipate the demise of industrial food production as the complexity of society breaks down and liquid fuel prices rise becomes less affordable. Therefore, we need to work on an alternative, regardless of the specific scale of the crisis. Once complex, fragile chains of food production and distribution spanning the world begin to break, it will be our duty to make sure that our families and communities can still eat!
2. Human Scale - Small-scale agriculture is capable of being implemented by normal people in normal circumstances, without extraordinary infrastructure, technologies or budgets. It is a grass-roots revolution powered by the people for the people. While many people may hope for technology to save them, they would might do better to unclasp their wringing hands and put them to work turning compost.
3. Provides Meaningful Employment - Small-scale agriculture generally requires a lot of different types of human labor. Once the use of energy-hungry machines becomes too expensive unavailable for farming, people will also have to step back in to complete the necessary tasks themselves. And, yes, some of it is "back-breaking" and some of it is repetitive, but much of it is also joyful, soulful, and fun. All of the work is skillful and rewarding.
4. Crucible for Innovation - While the latest app for telling a person his/her horoscope is added to the latest iProduct, we are reinventing the process of growing food. Small-scale farmers must not only re-discover lost knowledge but adapt it to current circumstances. This includes a variety of innovative practices, such as creating new hand-tools, bicycle powered root washers, specialized tractor equipment, online customer checkout systems specifically designed for CSA farms, new seed varieties, new rotations, and efficient, natural ways of fighting plant diseases and weeds.
5. Uplifting and Empowering - Many people feel dis-empowered by a global financial system that has left their expectations in tatters. Learning and practicing the skills that provide for your basic needs brings pride and security.
6. No Externalizations - Unlike the industries of the past that sprouted up, inflated to unsustainable proportions and then crashed, devastating the towns built around them, small-scale agriculture is diffuse and resilient. It simply relies on the soil, the weather and the sun, and it is not nearly as affected by the vagaries of distant markets.
I'm sure there's easily another solid twelve reasons why small-scale agriculture is such a positive force for change. How to revitalize a rural economy through small-scale agriculture is a much harder question to answer. Asking for the revitalization of rural economies through the use of small-scale agriculture is nothing short of a call for a revolution in our food production and distribution systems.
The Precedent Has Been Set in Hardwick, VT
The best way to conceive of this revolution is by illustrating a place where the challenge of rebuilding our food systems from the soil up has begun in earnest - Hardwick, Vermont (pop. 3000). The town had its best days in the 1920s, as it was a primary source for granite. When Granite was replaced by concrete as a building material, the industry collapsed. Therefore, the town has been in a sort of stasis for generations.
According to the US Census Report in 2000, the per capita income for the town was $14,813 per year, and about 10.5% of families and 14.0% of the population were living below the poverty line. The town's current unemployment is 40 higher than the state average in Vermont and its average median income is 25% lower. Like most American towns, the supermarket is peoples’ main connection to the industrial food system.
However, there's a growing and well publicized movement happening in Vermont that could provide some clues to the rest of us on how to proceed in a systemic process of revitalizing rural economies. There are many small and medium sized agricultural businesses in Hardwick that popped up within a short time frame and have been growing and making their positive influence felt.
The New York Times wrote an article featuring this movement back in 2008, and, despite the worsening financial meltdown that is tearing many communities apart, it still remains a viable and thriving model for Hardwick.
Uniting Around Food to Save an Ailing Town"This town’s granite companies shut down years ago and even the rowdy bars and porno theater that once inspired the nickname "Little Chicago" have gone.
Facing a Main Street dotted with vacant stores, residents of this hardscrabble community of 3,000 are reaching into its past to secure its future, betting on farming to make Hardwick the town that was saved by food.
With the fervor of Internet pioneers, young artisans and agricultural entrepreneurs are expanding aggressively, reaching out to investors and working together to create a collective strength never before seen in this seedbed of Yankee individualism. [..]
Rian Fried, an owner of Clean Yield Asset Management in nearby Greensboro, which has invested with local agricultural entrepreneurs, said he’s never seen such cooperative effort.
"Across the country a lot of people are doing it individually but it’s rare when you see the kind of collective they are pursuing," said Mr. Fried, whose firm considers social and environmental issues when investing." The bottom line is they are providing jobs and making it possible for others to have their own business."
These businesses include names like "High-Mowing Seeds", "Clair's Restaurant", "The Vermont Soy Company", "Jasper Hill Farm", "Pete's Greens" and "Highfield's Center for Composting". All of these companies and more describe the beginnings of how we take back our food systems and our rural economies in the process. They all carry important lessons for us to take notice of and adopt in our rural communities throughout the upcoming years of both industrial collapse and alternative agricultural opportunities.
Tom Stearns, Vermont local, is the owner and entrepreneur behind one of the few commercial organic seed producers in the country and one of the even fewer focusing on heritage or heirloom varieties. Heirloom varieties tend to pre-date the industrialization of our food supply. They are selected for flavor and nutrition, and adapted to local conditions instead of being selected to fit into a neat, efficient process. Mr. Stearns epitomizes the transition that is occurring in Hardwick, and its emphasis on cooperation and sharing.
NY Times (article linked above):"All of us have realized that by working together we will be more successful as businesses," said Tom Stearns, owner of High Mowing Organic Seeds. "At the same time we will advance our mission to help rebuild the food system, conserve farmland and make it economically viable to farm in a sustainable way."
Cooperation takes many forms. Vermont Soy stores and cleans its beans at High Mowing, which also lends tractors to High Fields, a local composting company. Byproducts of High Mowing’s operation — pumpkins and squash that have been smashed to extract seeds — are now being purchased by Pete’s Greens and turned into soup. Along with 40,000 pounds of squash and pumpkin, Pete’s bought 2,000 pounds of High Mowing’s cucumbers this year and turned them into pickles."
High-Mowing started out as a hobby for Stearns, who had a lifelong love of seeds, but soon it became a business. It's a $2 million/year concern that employs 30 people at reasonable wages. Besides providing employment, the business of growing seeds really gets to the heart of what it means to be resilient. Seeds and soil are obviously the basic foundations of agriculture and cannot be taken for granted, as most Americans tend to do.
The seed supply has become as inefficient and brittle as our money system and we risk more than we know by concentrating the breeding, growing and distribution of seed into the hands of a few. With men like Stearns at the forefront, who is more than willing to cooperate with other businesses in the community, the movement is in excellent hands. We enthusiastically buy our own seed from High-Mowing for some of our gardens.
Claire's Restaurant (Community Supported Restaurant)
CSRs are an adaptation of my farm's business model - Community Supported Agriculture. A group of five people started the restaurant and the funding model is as unique as the dishes you will find there. A holding company was created who bought the lease for the restaurant's building twelve years in advance. It turns out that pre-paying your lease for twelve years is a great way to negotiate a sweetheart rate!
NY Times:"Mr. Tasch is having a meeting in nearby Grafton next month with investors, entrepreneurs, nonprofit groups, philanthropists and officials to discuss investing in Vermont agriculture. Here in Hardwick, Claire’s restaurant, sort of a clubhouse for farmers, began with investments from its neighbors. It is a Community Supported Restaurant. Fifty investors who put in $1,000 each will have the money repaid through discounted meals at the restaurant over four years.
"Local ingredients, open to the world," is the motto on restaurant’s floor-to-ceiling windows. "There’s Charlie who made the bread tonight," Kristina Michelsen, one of four partners, said in a running commentary one night, identifying farmers and producers at various tables. "That’s Pete from Pete’s Greens. You’re eating his tomatoes."
The equipment that is needed to run a restaurant, and typically put a heavy burden on start-up capital, was purchased by the same holding company for use by the restaurant and any future food business that would take the place of Claire's Restaurant, should it fail. In this atmosphere of financial and social support, the chef, Steven Obranovich, is able to focus on cooking and, perhaps more importantly, the sourcing of ingredients.
That focus has led him to source an unheard of 80% of these ingredients from local farmers and businesses (it’s not just the garnish that is local). Here is both an outlet for the food being produced locally but also a place where people can meet, talk and spend time becoming ensconced in the spirit and vitality of eating food grown close to their homes.
Highfield's Center for Composting
This company provides a necessary service for any agrarian community. Good quality compost is in short supply and for many reason most new farmers take on market gardening as their initial venture into the world of agriculture. Without on farm fertility gardeners need a good non-chemical source of nutrients for their gardens. Thomas Gilbert, executive director and founder, is a composting guru and has a deep respect for what compost and fertility can mean to an agricultural community.
These are just three of the business’s that make up the incredible, unfolding story in Hardwick. Each enterprise is exciting on it's own but having so many agricultural business's so close together both in proximity and mission has the makings of big time change. As the NY Times article makes clear, the unprecedented level of cooperation between these businesses provides an atmosphere of economic stability and social cohesion.
NY Times:"For the past two years, many of these farmers and businessmen have met informally once a month to share experiences for business planning and marketing or pass on information about, say, a graphic designer who did good work on promotional materials or government officials who’ve been particularly helpful. They promote one another’s products at trade fairs and buy equipment at auctions that they know their colleagues need.
More important, they share capital. They’ve lent each other about $300,000 in short-term loans. When investors visited Mr. Stearns over the summer, he took them on a tour of his neighbors’ farms and businesses."
Center for an Agricultural Economy
The recently started Center for an Agricultural Economy is another organization in our community that will give shape and push this vision forward in a more organized and transparent way. Since the NYT article was written, this organization has remained strong and committed to Hardwick’s revitalization through small-scale agriculture, and the town’s residents, from farmers to business people to students, have benefited greatly as a result.
NY Times:"To expand these enterprises further, the Center for an Agricultural Economy recently bought a 15-acre property to start a center for agricultural education. There will also be a year-round farmers’ market (from what began about 20 years ago as one farmer selling from the trunk of his car on Main Street) and a community garden, which started with one plot and now has 22, with a greenhouse and a paid gardening specialist.
Last month the center signed an agreement with the University of Vermont for faculty and students to work with farmers and food producers on marketing, research, even transportation problems. Already, Mr. Meyer has licensed a university patent to make his Vermont Natural Coatings, an environmentally friendly wood finish, from whey, a byproduct of cheesemaking."
Hardwick's access to local food is unparalleled. It is likely that Hardwick could feed itself and the surrounding environs without any outside input. And while that may seem like a small thing, as all of us have become so used to the ubiquity of food, it bears remembering how incredible brittle our long food supply chains are. Most cities have about four days worth of food on hand at a time without constant delivery. A food system based on resilient parts - i.e. people and businesses - will itself be resilient as a whole.
Some Thoughts For You to Take Home
Agriculture is, of course, a primary industry, since it takes seed and soil and produces something of intrinsic value – food. This food, in turn, can result in a thousand secondary off-shoot industries. Think about a canning factory, a distillery, a community delivery service, or a candle manufacturer from Bee's wax? The possibilities boggle the mind, and every community will be different based on the needs and desires of its residents.
Small farms trade back the destructive relationship between fossil fuels and efficiency for the creative relationship between human labor and resiliency. Farms need year-round labor, and if you’re not riding the wave of a commodity grain, that means job stability. Stability means a stable local economy, but also stable families and households. There are as many opportunities in or around small-scale agriculture as you and your neighbors have energy for.
What does all of the above mean for you right this moment? Well, it certainly adds a lot of weight to the phrase, "buy local". The idea of buying local has allegedly been accepted and embraced by mainstream commentators, but they use it as little more than a catchy slogan. Instead, it should be understood as something radical and revolutionary! Resilient food producers out there are challenging the food system on all fronts.
So you’re not just reducing your carbon footprint and enjoying the tastiest, most nutritionally dense food, but you’re also -and perhaps most important of all- ensuring the long-term viability of your own community. If you're an investor, then why not put your money into a small-agricultural business or related industry? One of the largest barriers for new farm businesses is start-up capital. Banking institutions generally don’t understand the benefits of this kind of resilient endeavor, because they see no immediate profits to be gained.
The bottom line may look decent, but the return on investment (ROI) is very long-term and the interest might come in the form of hams, lettuce mix and soup stock instead of cash. But if you’re a frequent reader of The Automatic Earth, then you probably understand why nutritional food is a much better ROI. Instead of looking for a quick monetary profit, we can be satisfied settling for delicious food security.
It is obviously important to learn the proper skills and gain experience. There are certainly a lot of folks out there trying to farm without the proper business sense or agricultural knowledge to succeed. With access to online or community resources, though, it is never too late for people to get started on their rural revitalization education. The cities of our nations are where we have focused our attention, but I believe it's in the "empty spaces" where the room for creativity and reinvention of a more equitable and prosperous society will find its roots.
Innovation at the "human scale" is happening at the end of hoes and around micro-brews in a small town watering hole. Food is a basic need, it is non-negotiable and come rain, shine, deflation or inflation, we must eat! As the uncertain future looms large over all our lives, we need to be prepared both to survive and to thrive. For now, it is clear that people in some rural economies are feeling hopeful about agriculture for the first time in a generation.
The fault lines are shifting, as the fastest growing segment among farmers is young women! What better statistic to reflect change from the "traditional farmer" in our culture’s iconography, and the agricultural landscape in general. "Eating is an agricultural act," Wendel Berry famously said, and we are all engaged in this agricultural act every single day. Whether those acts benefit a few multi-national corporate networks or our next door neighbors is entirely in our hands.
To end this discussion, then, I will turn to the extremely informative and insightful book, The Town That Food Saved, written about Hardwick by Ben Hewitt.
The Atlantic Magazine interviewed Mr. Hewitt about the book last year, and he made clear that none of the things happening in Hardwick came without great patience and effort from the people and businesses of the community.
It is not easy to revitalize our rural economies after decades and decades of mis-allocation and mismanagement of resources. Still, with enough effort and imagination, Hardwick proves that this revitalization can be done.
In Rural Vermont, From Famine to Fork"In the course of researching The Town That Food Saved, Hewitt found that the issue of food systems was far more complex than he had first thought. "I wanted to ask what it really means to create a localized food system," he told me over coffee, one of the few items on his daily menu he does not produce. "It's hard—culturally, economically, and in terms of people's habits. Readers looking for empirical answers should look elsewhere. In a way, this book is more about questions than answers."
Still, Hewitt comes away feeling that Hardwick's recent history may be providing a template for a food system that could save all of us. "The fact is that our nation's food supply has never been more vulnerable. And we, as consumers of food, share that vulnerability, having slowly, inexorably relinquished control over the very thing that's critical to our survival," Hewitt writes. What is at risk, he contends, is the entire model of the way we nourish ourselves. Fixing this broken model is a matter of national urgency.
Should our industrial food system collapse, the Hewitt family (which includes his wife and two young boys) will have far less to worry about than most of us. They raise 80 percent of the food they eat: in addition to all their vegetables, they produce milk, beef, lamb, pork, chicken, eggs, blueberries, raspberries, apples, and maple syrup. Their house, which they built with help from friends, gets its electricity from solar panels and its heat from wood stoves.
Where does that leave the rest of us? "For 100 years food production has been headed in one direction," Hewitt told me. "The people I profile [in Hardwick] are all articulating steps to get us going in a different direction."
Markets rise but contagion fears spread to Spain
by Jonathan Sibun, and Harry Wilson - Telegraph
Political progress in Italy and Greece pushed stock markets higher but economists warned of stormy weeks ahead as attention turned to Spain amid fears it could be the next economy to come under the spotlight.
The FTSE 100 rose 100.57 – or 1.9pc – to 5545.38, closing a turbulent week 1.3pc higher. In Italy the FTSE MIB was up 3.7pc on the day, while France's CAC rose 2.8pc, the German Dax gained 3.2pc and in the US the Dow Jones closed 2.2pc higher. The rally came as bond yields fell with Italian 10-year debt touching 6.4pc on signs that politicians are finally recognising the scale of the crisis.
In Italy, hopes are growing that a new government could be installed as early as tomorrow after the Senate approved an economic reform bill, paving the way for Silvio Berlusconi's resignation. The austerity package, seen as crucial to averting an Italian bail-out, will go before the country's lower house today before an emergency government is installed. Mario Monti remains the frontrunner to succeed Mr Berlusconi.
"The most important element to overcome this crisis is a trusted and able new Italian government that can really fulfill the structural changes that are needed," said Ewald Nowotny, a member of the governing council at the European Central Bank (ECB).
Markets also took cheer as Lucas Papademos was sworn into office in Greece after days of political wrangling. Inspectors from the International Monetary Fund (IMF), European Union (EU) and ECB are set to visit Athens next week, potentially leading to the release of €8bn (£6.9bn) in bail-out funds.
Ioannis Mourmouras, a new assistant finance minister, said the new government's sole task was to implement the necessary austerity reforms: "Greece is at a crossroads. What is at stake is the future of the country within the eurozone."
While traders took comfort from progress in Italy and Greece, fears were growing over the health of the Spanish economy after GDP data showed the country grinding to a halt in the third quarter. Economists are increasingly sceptical that the eurozone's fourth largest economy will be able to meet deficit reduction targets.
"The economic recovery in Spain has ground to a complete halt," said analysts at ING. "We fear that the Spanish economy might slip into recession soon – perhaps as soon as the current fourth quarter. Our base case scenario envisages no economic growth in 2012."
Spain's deficit plans are predicated on the economy growing 1.3pc this year and by 2.3pc in 2012, targets seen as increasingly optimistic. With the country set to hold elections on November 20, a new government would likely have to push through further austerity measures, potentially leading to political infighting or popular opposition. Spain's bond yields have moved higher in recent days, ending yesterday at 5.9pc.
Fears have also been raised over the country's banking system with analysts pointing to an alarming outflow in retail deposits this year. About half the 2012 funding requirements of Spanish banks are planned to be met through deposits. Analysts at Barclays Capital argue this means the country's banks will need to see 4% growth in deposits, but so far in 2011 there has been 2% shrinkage.
Weighing on the banks further is the prospect of property write-downs. French broker Cheuvreux estimates that 50% of Spanish construction companies have either already defaulted on their loans or are likely to do so. Speculation is growing that much of the land held on the books of Spanish banks will have to be marked down significantly before year-end.
Fears over Spain's future came as the IMF issued a report – prepared for last week's G20 summit but only released yesterday – warning that advanced economies could fall back into recession unless world leaders moved with greater urgency to boost growth. The organisation raised particular concerns over how fiscal stability would be achieved in countries including the US and Japan.
Invisible Run on Banks Becoming Conversation With Italian Yields Above 7%
by John Glover and Elisa Martinuzzi - Bloomberg
Italy’s highest bond yields since the birth of the euro are reverberating through the financial system of Europe’s biggest debt issuer, driving lenders to seek record amounts of central bank financing.
Italian banks borrowed 111.3 billion euros ($152 billion) from the European Central Bank at the end of October, up from 104.7 billion euros in September and 41.3 billion euros in June, Bank of Italy data show. The five biggest lenders -- UniCredit SpA, Intesa Sanpaolo, Banca Monte dei Paschi di Siena SpA, Banco Popolare SC and UBI Banca ScpA -- accounted for 61 percent of the country’s use of ECB resources in September, almost double the share in January.
After punishing Greece, Ireland and Portugal for their rising debt loads, the bond market is now targeting Italy, pushing bonds yields in the euro zone’s third-largest economy above 7 percent as the nation’s lenders prepare to refinance $120 billion of debt maturing next year. Italy’s $2 trillion in liabilities exceed those three countries combined, plus Spain.
"The banks are deleveraging on a tightrope," Alberto Gallo, a credit strategist at Royal Bank of Scotland Group Plc (RBS) in London, said in an interview. The slump in Italy’s bonds, which sent the 10-year yield soaring to as high as 7.48 percent Nov. 9, is reducing the value of fixed-income securities held by banks, eroding their value as collateral for loans, Gallo said.
Bond investors charged the nation an interest rate of 6.087 percent yesterday to buy 5 billion euros of one-year bills, the highest in 14 years. Greece, Ireland and Portugal sought a bailout from the ECB, the European Union and the International Monetary Fund after their bond yields rose above 7 percent amid the region’s sovereign debt crisis.
As Italy’s government faces collapse after Prime Minister Silvio Berlusconi promised to resign once Parliament approves austerity measures, deputy finance ministers meeting at the Asia-Pacific Economic Cooperation forum in Hawaii this week expressed concern over the danger Europe poses to the world economy.
U.S. Treasury Undersecretary for International Affairs Lael Brainard said European officials must speed up construction of a "firewall" to protect countries that have sound policies. The 17-nation euro has fallen as much as 5.4 percent since Oct. 27.
International Monetary Fund fiscal monitors are due to visit the Italian capital, and European Union Economic and Monetary Affairs Commissioner Olli Rehn says he wants answers to "very specific questions" on economic pledges by the weekend. U.K. Prime Minister David Cameron said Italian interest rates are "getting to a totally unsustainable level."
The extra yield investors demand to hold Italian 10-year debt rather than German bunds rose to a euro-era record 5.53 percentage points on Nov. 9 before falling back to 5.12 percentage points.
Italy’s top 32 banking firms have about 88 billion euros, or 3.2 percent of their liabilities, maturing in 2012, according to the Bank of Italy. Next year’s maturities coincide with about 307 billion euros of the government’s debt coming due, the most ever, according to data compiled by Bloomberg.
Italian lenders are seeking to broaden their sources of funding. Corrado Passera, the chief executive officer of Intesa Sanpaolo SpA (ISP), said on Nov. 8 the bank can do without wholesale funding for all of next year, and rely on deposits and bonds it sells to individual customers.
Retail funding made up 54.1 percent of the Italian banking system’s total as of June, compared with 48.8 percent in the rest of the euro zone, according to the Bank of Italy. The cost of that money increased 0.4 percentage point, or 40 basis points, to 1.7 percent in the nine months ended Sept. 30 as the funding mix shifted to products such as repurchase agreements and fixed-term deposits that pay clients more, central bank data show.
Italian banks’ share of ECB lending rose to about 19 percent of the total in October, according to the Bank of Italy. That’s up from 15 percent, or 91 billion euros, in September, the data show.
"The Italian banks are trapped," said Roger Doig, a London-based analyst at Schroders Plc, which manages about $58 billion in fixed-income assets. "They are where they are and that’s with the Italian sovereign. The austerity required if the sovereign wants to remain in the euro zone means there’s going to be a recession, which will mean losses for the banks."
Credit-default swaps tied to the senior debt of UniCredit, a proxy for the cost of funding at Italy’s biggest lender, jumped 150 basis points this month to 502 basis points, approaching the record 504 reached in September. Contracts on Intesa Sanpaolo, the second-largest, jumped 129 to 467, also close to an all-time high, according to CMA in London. Five-year contracts on Italy were little changed at a record 570 basis points, up from 239 at the beginning of the year, according to CMA.
Credit-default swaps typically decrease as investor confidence improves and rise as it deteriorates. They pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt. "The market is pricing in an Italy event and assuming that Italy fails," said Patrick Lemmens, a senior money manager who helps oversee about $13 billion, including Intesa Sanpaolo shares, at Robeco Groep in Rotterdam.
Household deposits in Italy still are expanding "at a moderate pace," according to the Bank of Italy. That’s a contrast to withdrawals seen in Greece, Ireland and Portugal.
The annual rate of decline in Irish private-sector deposits was 10.5 percent at the end of September, according to that nation’s central bank. In Greece, deposits fell 2.9 percent in September for a net outflow of 6.29 billion euros, the biggest one-month drop since the start of the crisis, according to Manos Giakoumis, research director at Euroxx Securities SA, an Athens- based brokerage.
Italy’s lenders started increasing their reliance on the ECB in July, when end-of-month borrowings from the central bank minus the amount deposited reached 58.8 billion euros, according to John Raymond, an analyst at CreditSights Inc. in London. Before that, net borrowings from the ECB ranged from 9 billion euros to 30 billion euros, he said.
The amount surged to a record 87 billion euros at the end of October, according to Raymond, citing Bank of Italy figures. "This is all symptomatic of what’s going on around the banks," Raymond said. "Everything hinges on the sovereign."
RBS economists forecast a recession in Italy in the fourth quarter, and expect the economy to contract 0.2 percent in 2012. The government’s austerity packages, totaling 124 billion euros and including cuts to health care, pensions and regional subsidies, are adding to the recession risk, said RBS’s Gallo.
Italian institutions can borrow what they need in the ECB’s refinancing operations, paying the current policy rate of 1.25 percent as long as they have the required collateral. Lenders have "ample availability" of ECB-eligible assets, according to the Frankfurt-based central bank, and can help themselves by ensuring the assets are suitable as security. Intesa Sanpaolo said it’s looking to increase ECB-eligible assets to 100 billion euros from the current 83 billion euros.
The ability to fund at the ECB is vital for Italy’s banks that can’t access markets, though the central bank is keen to wean borrowers from its support. The ECB applies a discount on securities used as collateral to protect itself against loss. "Italian banks have been crushed in the carnage in the government bond market," said Suki Mann, a strategist at Societe Generale SA in London. "It could get worse."
Europe’s Banks Turned to Safe Bonds and Found Illusion
by Liz Alderman and Susanne Craig - New York Times
As the bets that European banks made on United States mortgage investments went bust a few years ago, bankers piled into what they saw as a safe refuge: bonds issued by countries in Europe’s seemingly ironclad monetary union.
Now, the political and financial crisis engulfing the Continent has turned much of that European sovereign debt into the latest distressed asset, sending tremors through global financial markets not seen since the demise of the investment bank Lehman Brothers more than three years ago.
This week, shortly after European leaders formally conceded that Greece could not pay its debts and forced banks to accept losses, the shock waves reached Italy, the third-largest economy in the euro zone after France and Germany. And despite frantic efforts by politicians to contain the damage, market analysts said that France, one of the strongest countries in the euro zone, may soon feel the impact.
"When people started buying more European sovereign debt, there was not a cloud in the sky," said Yannis Stournaras, director of the Foundation for Economic and Industrial Research, based in Athens. Now, he said, "This crisis is going to last because the perceptions of risk have changed dramatically."
European banks face tens and possibly hundreds of billions of dollars in losses on loans to nations that use the euro. Worried about even greater losses if the crisis worsens, the banks have been scrambling to reduce their holdings of an investment that, like triple-A-rated subprime mortgage bonds, was once thought to be bulletproof.
The French bank Société Générale, for instance, this week marked down 333 million euros of its Greek sovereign debt holdings and in October slashed its exposure to that country to 575 million euros, from 2.4 billion euros at the beginning of 2011. Another French bank, BNP Paribas, has cut its holdings of Italian government debt 40 percent since July, to 12.2 billion euros.
How European sovereign debt became the new subprime is a story with many culprits, including governments that borrowed beyond their means, regulators who permitted banks to treat the bonds as risk-free and investors who for too long did not make much of a distinction between the bonds of troubled economies like Greece and Italy and those issued by the rock-solid Germany.
Banks had further incentive to overlook the perils of individual euro zone countries because of the fees they earned for underwriting sovereign debt sold to other investors. Since 2005, several dozen banks in Europe and the United States have earned $1.1 billion in fees from selling bonds for European governments, according to Thomson Reuters and Freeman Consulting Services.
Like other investors, banks clung for a long time to the seemingly inviolable belief that all the countries using the euro would make good on their debts. For years, Greek and Italian bonds did not pay much more than German ones, but banks were always hungry to chase even a fraction of additional profit. For much of the last decade, they bought the higher-yield bonds, ignoring the growing political and fiscal problems of those countries as well as other peripheral euro zone nations like Ireland, Spain and Portugal.
Regulators bear much of the responsibility. Before 1999, when Europe forged its monetary union, regulators permitted banks to treat as risk-free the debt of any country that belonged to the Organization for Economic Cooperation and Development, a club of developed nations that includes the United States and most of Europe.
"There was encouragement from European authorities for banks to load up on more debt, because it was seen as safe," said Nicolas Véron, a senior fellow at Bruegel, a research firm in Brussels. "In hindsight, it was unwise risk management."
Some regulators realized that allowing banks to set aside no capital for sovereign defaults could be a problem and moved to address it in a 2006 accord known as Basel 2. They mandated that big, complex banks use their own models to determine if individual countries were at risk and hold some capital against them. But the European Union never enforced the stiffer regime. And amid the subprime mortgage crisis, Europe’s regulators added to the problem by demanding that banks hold more safe assets, much of it sovereign debt.
As a result, banks were not discouraged from placing their most liquid assets "into the worst possible government debt," Achim Kassow, a former Commerzbank board member, wrote in a study published by the European Parliament.
Now, Société Générale, Commerzbank and other banks cannot get rid of the shaky debt fast enough. In the last several months, they have booked billions of euros in losses from unloading it, although their exposure remains substantial. Including the effect of hedges, European banks had a net exposure of about $120 billion to Greek government borrowings and private debt at the end of June, according to the Bank for International Settlements. Even more worrisome, analysts say, is the banks’ exposure of $643 billion to Spain and $837 billion to Italy.
Banks in the United States are also caught in the crossfire. For Italy alone, they had $47 billion in net exposure to government borrowings and private debt at the end of June, the B.I.S. data show. Goldman Sachs has $700 million in exposure to Italy, according to a regulatory filing released this week, and could feel the fallout if the bonds were marked down.
The loss from a write-down similar to that on the Greek debt — 50 cents on the dollar — would erase 10 percent of the $3.43 billion in profit Goldman earned in the first nine months of the year.
Regulators are requiring European banks to raise 106 billion euros in new capital by next summer to protect themselves against further losses. Banks insist the risks are manageable. But the big fear is that they do not have enough capital to cover potential losses from the euro zone. That kind of crisis of confidence drove MF Global, the large New York brokerage firm, into bankruptcy last week after its $6.3 billion bet on European debt alarmed investors.
While the markets are now being brutally efficient in telegraphing the differing debt risks among European countries, they failed in that function for a long time, just as they failed to reflect the risks of subprime mortgage loans as a real estate bubble formed in the United States.
For most of the last decade, bond yields among Germany, Greece, Portugal, Ireland, Italy and Spain traveled in a tight pack. That meant investors buying and selling those bonds acted as if the countries were almost equally safe simply because they were members of the euro zone, despite shaky finances in Greece, real estate bubbles in Ireland and Spain and high debt in Italy.
The phenomenon rang alarm bells as far back as 2005, when banks, national treasuries and the European Commission held intense internal debates on why the spreads between Germany and other countries did not seem to reflect the differing risks, said a senior Brussels official involved with bank regulation. When the subprime crisis started to buffet Wall Street in 2007, banks sought shelter by turning even more to European sovereign debt, especially countries with the best returns.
The B.I.S. data show that bank lending to the governments of Portugal, Ireland, Italy, Greece and Spain, largely through bond purchases, rose faster than usual, by 24.2 percent, to $827 billion, between the second quarter of 2007 and the third quarter of 2009, when the crisis in Greece first started to taint European sovereign debt.
Banks across the world joined in this lending binge as they chased higher yields. Emblematic of those that took the plunge was Komercni Bank, a large bank in the Czech Republic that is majority-owned by Société Générale.
As the subprime crisis in America began mounting, Komercni veered into the seemingly safe Greek government bonds. The bank’s entire board, more than half of whom were long-time veterans of Société Générale, signed off on Greek debt purchases from 2006 through 2008. Now the bank is expected to write down an additional 2 billion koruna, or $111 million, on its Greek debt this year, after taking a 1.66 billion koruna hit in the second quarter. That is a manageable amount, but the bank would have been barely affected if it had bought the safer German bonds.
As the subprime crisis peaked on Wall Street, banks sharply increased their underwriting of European sovereign debt. In 2007, the world’s big banks made $113.9 million in underwriting fees; by 2009, that number had more than doubled to $273 million.
Société Générale went from issuing no Greek debt in 2005 to being the world’s eighth-largest underwriter just a year later. The bank has made $61.5 million in fees from underwriting debt for euro zone countries since 2005, according to Thomson Reuters. Deutsche Bank, the top underwriter of euro zone debt in that period, took in $87 million in fees.
Banks in the United States also profited. Since 2005, Goldman Sachs has earned $44.5 million in fees underwriting euro zone debt, and Morgan Stanley has earned $47.4 million, according to Thomson Reuters. Their special relationship with governments sometimes also presented a unique dilemma: it gave banks little incentive to publicize red flags even if they were suspicious about sovereign debt.
In 2005, Marc Flandreau was a senior adviser in Paris at Lehman Brothers, one of several banks selling sovereign bonds for the French government. He suddenly wondered whether France’s finances were solid enough to merit the low interest rates at which it and the other members of the euro zone were selling their bonds. He wrote a memo to the French Treasury expressing his concerns.
"They went totally ballistic," Mr. Flandreau recalled. "They said, ‘You guys should shut up, you’re selling our stuff.’ "
Benoît Coeuré, an official at France’s debt-issuing agency at the time, insisted that the policy was not to discourage the banks from analysis. But "if it had a negative tone on French policies," he said bluntly, "my role was to object to it."
Today, with Europe’s sovereign debt crisis seemingly spinning out of control, regulators are pressing governments and banks to divulge as much risk as they can and are asking banks to set aside billions of euros to protect against possible losses.
"Sovereign debt has lost its apparent risk-free status," Hervé Hannoun, deputy director general of the Bank for International Settlements, said in a recent speech in which he called for an end to "the fiction." To restore confidence, he concluded, the world needs to move "from denial to recognition."
Which eurozone country's debt has been most volatile over the last two days? No, not Italy's
by Nils Pratley - Guardian
While the yield on Italian bonds stabilised at just below 7%, France's has been rising to a record spread over the German bund
Question: whose 10-year bond yields have risen more in the past two days' trading: Italy or France?
The answer is France, which has travelled from 3.15% on Wednesday morning to 3.48% Thursday afternoon (as at 6pm). Italy has gone from 6.75% to 6.95%. Of course, that's not the main story of the week, since Italy ended last week at 6.3% and touched 7.5% during Wednesday's drama. Even so, the blow-out in France's spread over Germany – a record in the euro era of 168 basis points – illustrates how the crisis is spreading.
Standard & Poor's, which erroneously dispatched a message on Thursday that France's credit rating had been downgraded, can't take all the blame (though the "technical error" was appalling). The deeper reasons include:
- French banks are carrying more Italian debt than anybody else – about €300bn worth. That's on top of the writedowns they are currently taking on their large Greek exposures.
- Within the worsening outlook for eurozone growth published by the European commission on Thursday, France came off badly. Don't expect growth of 2% next year: the new figure is just 0.6%.
- A credit rating change now seems more likely, even if S&P has fixed its computer. In the tail-wags-dog world of ratings agencies, higher yields tend to make downgrades more likely.
- There is the worry that any attempt at bailing out Italy would put intense pressure on France. The European financial stability facility is backed by guarantees from member states. Italy obviously couldn't give guarantees on loans to itself, so a greater burden would fall on others. Alternatively, any officially sanctioned "haircut" for holders of Italian debt would rebound on French banks.
Valérie Pécresse, the French budget minister, is entitled to argue that France is "not at all in the same situation" as Italy. The trouble is, in the eyes of some investors, betting against French bonds has suddenly become two bets for the price of one. It's a cheap way to bet against the eurozone finding a painless solution to the Italian muddle; and it's a way to gamble that the latest French austerity package, a mix of tax rises and spending cuts, won't be enough to hit the deficit targets and thus satisfy ratings agencies.
'France will be the next to crumble', warns Gordon Brown
by Henry Samuel - Telegraph
France risks becoming the next victim of the sovereign-debt crisis "in the coming weeks", Gordon Brown, the former prime minister, has warned.
Mr Brown’s prediction came as the difference between French borrowing costs and those of Germany hit record levels. EU leaders urged France to draw up further austerity measures to meet its deficit reduction targets, amid fears the eurozone’s second biggest economy could crumble if Italy’s debt crisis spirals out of control.
Mr Brown, speaking in Moscow, said: "France is in danger of being picked off by the markets in the coming weeks and months." He urged Nicolas Sarkozy, the French president and current G20 chairman, to draw up a "global growth agreement" with major powers such as China. Such a deal could help to support the EU, whose bail-out mechanisms are not big enough to prop up a major nation.
Mr Brown’s speech echoed Olli Rehn, the EU economics commissioner. Mr Rehn urged France to take further steps to cut its public deficit to a limit of 3 per cent of gross domestic product in 2013 from an estimated 5.7 per cent this year. He said it was set to miss those targets by a wide margin. "We believe that it is best that France announces, as early as possible, the measures that are needed to keep its deficit in line with the official targets for 2012 and 2013," he said.
The "spread" or difference between German and French 10-year government bond rates – the cost of state borrowing which reflects investor confidence – hit a high of 170 basis points yesterday before falling back. At the close, the interest rate or yield on a 10-year French bond was 3.46 per cent, while its German equivalent was 1.78 per cent.
On Monday France announced a €65 billion austerity package over five years – its second in three months – to retain the triple-A credit rating, which allows it to borrow at the lowest rates.
The credit agency Moody’s put France under "observation" last month and could revise its rating in January. Mr Sarkozy announced a €12 billion package in August consisting mostly of small tax rises and the abolition of tax breaks. That was to respond to it revising down its growth forecast for next year from an optimistic 1.75 per cent to 1 per cent.
The European Commission yesterday scaled down its forecast for French growth to just 0.6 per cent next year as it warned that the debt crisis risked dragging the entire bloc into recession.
With presidential elections in France just six months away, the unpopular Mr Sarkozy is staking his credibility on deficit reduction, as he tries to convince voters he is a safer pair of hands than his Socialist rival, François Hollande. This in part explains why his government dismissed the suggestion it needed more austerity measures yesterday. But a chasm appeared to be opening between Europe’s two big economies.
"Let’s not have any illusions," said Jacques Attali, a former adviser to president François Mitterrand and head of the European Bank of Reconstruction and Development. "On the markets French debt has already lost its triple-A status."
One Elysée Palace official told Le Monde newspaper: "If Nicolas Sarkozy loses our triple-A, he is dead." In a sign of market jitters, the ratings agency Standard and Poor’s mistakenly announced to some clients a downgrade of France’s credit rating to AA. It later apologised for a "technical error".
Eurozone crisis threatens to spread to France as Paris is warned over its debts
by Phillip Inman - Guardian
Nicolas Sarkozy's government told to do more to cut state spending as figures reveal a slump in the country's industry
France is under pressure to reassure markets that it can cope with the deteriorating situation in the eurozone, after official figures showed a slump in industrial production that could wipe out any chance of growth next year.
The eurozone's second largest economy came under fire from the European Union and international investors for not doing more to cut government spending amid fears the debt crisis would escalate and ensnare the French economy.
Bond yields, which determine the interest rate for government borrowing, rose as France snubbed the EU call for more austerity measures, saying the country's latest round of belt tightening would be enough to bring its deficit within EU limits. The gap between French and German bond yields hit a new record as German yields fell to 1.78% and French yields rose to 3.48% on 10-year bonds.
The febrile atmosphere surrounding Paris was heightened after the ratings agency Standard & Poor's mistakenly issued a notice stripping France of its coveted AAA rating. The agency has threatened to issue a downgrade, which would push up bond yields further, but said the document was a mistake. Some economists said the gloomy picture in France meant the country had fallen out of the first rank of euro nations.
Much of its success in recent years had depended on making loans to peripheral eurozone countries, many of which were now in deep trouble and possibly unable repay all their loans. French banks have written off most of their loans to Greece, but would need a big bailout by French taxpayers if their loans to Italy suffered a similar fate.
Estimates French banks have lent around €300bn to the Italian government and Italian banks meant Paris could struggle to avoid being drawn into the debt crisis. President Nicolas Sarkozy's government announced on Monday a second savings drive in three months, as it battles to keep its deficit targets within reach in AAA rating as one of the world's safest borrowers.
Forecasting lower growth in France than the government, EU economic and monetary policy commissioner Olli Rehn urged further steps to ensure France is able to cut its public deficit to an EU limit of 3% of GDP in 2013 from an estimated 5.7% this year.
"We believe that it is best that France announces, as early as possible, the measures that are needed to keep its deficit in line with the official targets for 2012 and 2013," Rehn said. But French finance minister Francois Baroin and budget minister Valerie Pecresse said the latest saving measures had built in leeway to offset the impact of lower than expected growth both in 2012 and 2013.
French industrial production slumped 1.7% month on month in September, coming in lower than expected. The poor figures were compounded by a Bank of France business sentiment indicator that fell back to 96 in October, from 97 in September and a prediction by the EU that France would grow at 0.6% next year instead of the previous estimate of 2%.
Michael Derks, Chief Strategist at currency trader FxPro, said a break-up of the euro would leave France outside the top rank. "The 'outs' will likely consist of Greece, Portugal, Ireland, Italy and Spain, while the 'ins' would definitely be Germany, Austria, the Netherlands and Finland. France would be aghast at not being an automatic inclusion in this 'in' group, but the way its bond yields are headed, membership is definitely not guaranteed. Likewise, Belgium is also in danger of being cast adrift."
Stephen Lewis, chief economist at Monument Securities said: "The Mediterranean nations' economies almost certainly diverge too far from the German template for them to sustain the fiscal discipline that the new arrangements would demand. The question is whether even France would be able to keep up.
Doubtless, the Franco-German negotiators would maintain the presumption that it could, seeing that divergence between France and Germany would defeat the purpose of the EU. But that political imperative might still run counter to economic reality.
Austria seeks to calm investors as debt yields rise
by Tracy Alloway - FT
Fears over Europe’s intensifying debt crisis have spread to the Austrian bond market, with the interest rate premium demanded by investors to hold the country’s debt over that of Germany rising to a euro-era record. A sell-off in Austrian debt on Friday prompted the country’s finance ministry to insist that its top-tier triple A bond rating was not in jeopardy.
Austria is regarded by investors as having close financial ties to Italy, where Rome’s debt has sold off this week amid political turmoil and following a decision by one of Europe’s largest clearing houses to require traders to post more collateral to buy and sell Italian debt. That, in turn, sparked a sell-off of French government bonds, where yields on 10-year government bonds have increased almost 39 basis points since the start of the week.
On Friday, even as French and Italian bond yields traded below this week’s highs, investors began selling heavily the triple A-rated bonds issued by Austria. "Austrian debt has basically gravitated with France," said Marc Ostwald of Monument Securities. "People have always perceived France and Austria to be vulnerable – Austria in particular because of its exposure to Italy and also eastern Europe."
Austria is one of a dwindling number of countries in the eurozone that are still triple-A rated. These include Germany and France. The country is also one of the more significant guarantors of Europe’s €440bn rescue fund, the European Financial Stability Facility.
There has been speculation in the markets that Austria might lose its coveted AAA-rating because of worsening market conditions for Italy. No rating agency has acted. "Friday rumours about rating downgrades have become regular occurences," said Mr Ostwald.
The yield on 10-year Austrian debt has surged at least 42 basis points since the start of the week, reaching 3.44 per cent on Friday. German debt, meanwhile, has barely moved despite the deepening eurozone crisis, with 10-year yields at 1.79 per cent. The spread between the two countries’ debt rose to 165 bp.
Austria has largely avoided the spotlight since the 2009 market turmoil in central and eastern Europe, when markets fretted over the strength of the region’s and possible contagion to countries like Austria. However, Moody’s, the rating agency, said earlier this month it had put Austria’s Erste Bank on review for a possible credit rating downgrade.
Vienna sought to reassure nervous investors, with the finance ministry publishing a statement saying that the country’s credit rating was "secure".
Slovenian Bond Yield Breaks 7%, First Time Since Euro Entry
by Boris Cerni - Bloomberg
Slovenia’s 10-year government bonds slid for a fourth day with the yield topping 7 percent for the first time since the nation adopted the euro in 2007 as the debt crisis in Europe roils markets.
The yield rose to 7.045 percent at 11:46 a.m. in Ljubljana, according to Bloomberg data. The difference, or spread, investors demand to hold the securities instead of similar maturity German debt also advanced to a euro-era record of 535 basis points. A basis point is a hundredth of a percentage point.
Slovenia, which holds early elections next month, was cut by Standard & Poor’s, Moody’s Investors Service and Fitch Ratings on the government’s collapse, the poor economic outlook and a weak banking industry. The former Yugoslav republic is also a victim of its "proximity" to Italy, which is struggling to fend off an investors’ crisis of confidence.
"The worry is that turmoil in Italy will last for some time, pushing Slovenian bond yields even higher," Michal Dybula, an economist at BNP Paribas in Warsaw, Poland, said in a phone interview yesterday."However, even if they breach the 7 percent mark that would not be the same evil as in Italy."
Slovenian bond yields started to advance since voters rejected pension changes in a June referendum. The spread versus German debt at the time was 147 basis points. The export-driven economy will expand 1.1 percent this year, down from a previous estimate of a 1.9 percent expansion, the European Commission said in a report yesterday.
Gross domestic product growth slowed to an annual 0.9 percent in the second quarter from a 2.3 percent pace in the first three months. The central bank sees GDP expanding 1.3 percent this year. Slovenia’s outgoing Finance Minister Franc Krizanic declined to comment on the yield advance today at a bankers forum in Brdo near the capital Ljubljana. He said the country shouldn’t have financing problems until 2014.
Permanent Bailout Fund Said to Face Delay on Bond Loss Clash
by James G. Neuger - Bloomberg
European efforts to speed the setup of a permanent rescue fund have lost momentum amid a clash between Germany and France over provisions to force bondholders to share losses, three people involved in the negotiations said.
Finance ministers failed to bridge divisions this week over the European Stability Mechanism, lessening the chances of activating its 500 billion-euro ($680 billion) war chest next July, said the people, who declined to be identified because the talks are in progress. Officials had hoped to bring the ESM’s start date forward to mid-2012 from its ultimate deadline of July 2013, the people said.
Germany and the Netherlands are resisting pleas by France, Spain, Portugal and Ireland for the bondholder-loss provisions to be stripped from the ESM treaty, the people said. It’s possible that officials will still beat the July 2013 deadline, the officials said.
"You have different political entities that have to come together and that’s very hard to do," Alexander Friedman, Zurich-based chief investment officer at UBS Wealth Management, told Bloomberg Television’s "The Pulse" with Maryam Nemazee.
European officials are scrambling to pull together as much money as they can to show investors they can stamp out the region’s worsening debt crisis. Operating the ESM in combination with the 440 billion-euro temporary fund next year would potentially boost Europe’s anti-crisis resources to 940 billion euros.
'Exceptional and Unique'
"Private sector involvement" was foreseen in a first version of the ESM treaty, signed July 11. Ten days later, euro government leaders negotiated writedowns on Greek debt, declaring that treatment as "exceptional and unique."
The opponents of bondholder-loss provisions seized on that declaration to press for amendments to the ESM treaty. The July 21 summit also foresaw additional powers for the temporary rescue fund, and for the ESM as well. They include bond purchases and extending emergency credit lines to distressed European nations. As a result of the new powers, the freshly inked ESM treaty had to be rewritten before being sent to national parliaments for ratification.
In parallel, the European Commission and governments including Finland called for the ESM to be set up a year earlier. The clash at the Nov. 7 meeting of finance ministers also made it impossible to ready the new treaty by Nov. 19, when Spain’s parliament dissolves before elections.
That means the euro zone will miss a self-imposed end- November deadline for signing the new version. The earliest that can now happen is January, one of the people said. It’s also possible that earnest discussions of the revised version at ministerial level won’t resume until January or February, another said.
Market volatility limits EFSF firepower
by Peter Spiegel - FT
This week’s market upheaval in Europe has made it difficult to increase the firepower of the eurozone’s €440bn rescue fund to the €1,000bn that the bloc’s leaders had hoped for, the fund’s chief executive said on Thursday.
Investors have fled from bonds issued by highly indebted countries. Luring them back by offering insurance on losses – the centrepiece of a plan agreed in Brussels on October 26 – would now probably use up more of the fund’s resources, Klaus Regling, head of the European financial stability facility, said.
His concerns underline Europe’s difficulties in putting in place mechanisms to contain the sovereign debt crisis and, if necessary, help Italy cope with soaring refinancing costs. "The political turmoil that we saw in the last 10 days probably reduces the potential for leverage," Mr Regling told reporters. "It was always ambitious to have that number, but I’m not ruling it out."
The European Commission sharply downgraded its forecast for eurozone growth next year from 1.8 per cent to 0.5 per cent. The global ramifications of Europe’s economic woes became clearer with the growth in China’s exports to the EU slowing in October and a sell-off in Asian equities markets.
The loss-guarantee programme aims to leverage the €250bn ($340bn) remaining in the EFSF to cover more than four to five times the value of bonds than if the fund purchased the bonds outright. But Mr Regling said heightened investor skittishness meant the guarantees would now have to be bigger in order to convince investors to participate, meaning the fund was likely to have only three to four times the firepower.
Leveraging the EFSF’s dwindling resources is the cornerstone of a plan to increase so-called "firewalls" to prevent the turmoil in Greece from spreading to European banks and its largest economies, particularly Italy.
One of the two options being explored – a plan that some officials say is the most developed – would guarantee Italian bondholders against part of their losses. Officials had hoped new investors could be enticed by a guarantee against a 20 per cent loss but those investors may now be seeking up to 30 per cent – which would limit the expanded firepower of the fund to about €800bn.
Mr Regling said he believed confidence in eurozone bond markets would return, particularly after Greek and Italian politics becomes more settled, meaning the fund may eventually reach the €1,000bn mark. "At least for a while, maybe the leverage is less than what we hoped three weeks ago," he said. "My expectation is it will get better because we do have a new government in Greece, and that helps."
With new powers that were formally granted three weeks ago, the EFSF could assist Italy quickly by buying Italian sovereign bonds at auction, a move that would significantly reduce Rome’s borrowing costs. Italy’s next major bond auction is on Monday.
But Mr Regling said he was reluctant to move so quickly, since he has been told to focus on the leveraging project before deploying the new powers. If the EFSF assisted Italy before leveraging was completed next month, it would have to use its own resources, depleting the €250bn remaining in the fund.
"Most people agree we should first conclude our work on leveraging so the firewalls we are trying to erect are convincing," he said. "We are not eager to act next week, because we don’t have the leveraging in place."
Christophe Frankel, the EFSF’s chief financial officer, said the fund was prepared to offer short term bills to raise money quickly and said such an offering was likely before the end of the year. In the past, the EFSF has only been able to raise funds for bail-outs through five and 10-year bond offerings, a long and complicated process that makes it difficult to raise cash in an emergency.
But Mr Frankel said the legal paperwork to issue bills was already in place and the programme could be triggered immediately, if needed. "The beauty of the bill programme is you can start with an amount which is a few billion and then raise it very rapidly," Mr Frankel said. "Once it exists, we know we can raise huge amounts in a very short time."
Writing on the Wall: Banks bigger issue than Italy
by David Weidner - Marketwatch
Silvio Berlusconi isn't the problem. Italy's spending isn't the problem. It's not unions or benefits. The euro zone isn't the problem. Neither are Greece, Jose Manuel Barroso, Nicolas Sarkozy or Angela Merkel. The problem is the banks.
For more than two years of crisis in Europe, the blame game has shifted from politicians to workers to central bankers and rating agencies. Round and round we go, like a Fiat on the Champs Élysees roundabout.
Banks, on the other hand, have endured some criticism, but they are largely unacknowledged in the notion that the mess makes the responsible nations of Europe (Germany, France and those fastidious Finns) vulnerable to the unrepentant spenders of Greece, Italy, Spain, Portugal and Ireland.
But when you get right down to it, the problem and its solution ultimately fall on the global banking industry. Banks created a bubble through irresponsible lending that swelled government treasuries and facilitated spending. Banks now hold much of the debt those nations issued. The banks would suffer most should Italy and Greece default-or a bailout prove insufficient.
If the fallout were limited to the banks, we could all just go home and talk about Champions League soccer. Or, as we like to do in America, ignore Europe altogether. Unfortunately, we've found out the hard way that we live in a world where when one bank fails, it crushes a nation's economy, a continent's and even the world's. Thank you, Lehman Brothers Holdings Inc.
It's not just the failures. Bank bailouts have a similar, if not as potent, effect. Bailouts hamstring banks and squeeze lending. As we all know, credit makes the world go round and economies percolate. Global regulators tell us there are about 30 of these too-big-to-fail institutions around the world. Thirteen of those institutions are in Europe. The total is 17 if you include the U.K.
Now, consider the sovereign debt the same financial firms hold. As of midyear, French and German banks had $90.7 billion in exposure to Greece's sovereign debt. To make matters worse, Italian and Portuguese banks had a combined $11.4 billion in exposure, according to the Bank for International Settlements.
Now look at Portugal. Weakling Spain had nearly $85 billion in bank and nonbank exposure to its Iberian neighbor. Germany had close to $40 billion in exposure, and France nearly $30 billion, according to the BIS.
Finally, Germany held $180 billion in Spanish debt, while France had $140 billion. Even the U.S. had close to $50 billion in exposure, with $19.5 billion of that on bank balance sheets. "Due to the close links among the financial markets of advanced economies, distress of one sovereign can spill over to other sovereigns and banks," BIS researchers wrote. "Contagion may also be induced by banks' claims on non-bank private entities in countries hit by sovereign tensions."
Now the world's financial system is exposed to the European financial crisis. Thicker lines show a greater exposure. We call this a "sovereign debt" problem, but it's really a bank problem. The BIS notes that banks remain massively interconnected. There's a graphic in the BIS report that illustrates the problem. It looks like a thick spider web or a tangled ball of twine.
What really is striking in the graphic is the size of the U.S. connections with at-risk euro-zone countries. There isn't much in the way of direct exposure. But the graphic also illustrates the deep connections U.S. financial institutions have with Germany, France and Britain. In turn, those countries have significant exposure with every weakling in Europe.
In other words, the U.S. is just a step away from a full-blown financial crisis at a time when it's still trying to dig out from its own. That's why, when we mischaracterize the problem as being one of governmental responsibility, we come dangerously close to making the same mistake we did when we called the financial crisis the "mortgage crisis" or the "housing crisis."
It's not that those labels are wrong. They just don't get at the heart of the matter. Whether it's a subprime mortgage in Las Vegas or a bond in Italy, the middleman is the bank. The bank is closest to the situation and historically responsible for monitoring credit and risk.
I'm not suggesting countries need to rein in spending or that we need to rethink what benefits or entitlements are necessary for workers of the world. It doesn't mean that austerity or forgiveness aren't important issues.
But if the world is really serious about avoiding financial crises in the future, then regulators are going to have to come together and deal with the undeniable facts: Banks have become too big, too important, too dependent on government aid and too dangerous.
Global banking is necessary in a global economy, but when it becomes more powerful than any nation or any group of nations and governments, then it is incumbent on those nations and governments to alter the balance. Blaming Berlusconi is like blaming a mortgage borrower who couldn't pay. Sure, there's some fault, but it takes two to make a deal.
EU Lowers Euro-Region Growth Forecasts
by Simone Meier - Bloomberg
The European Commission cut its euro-region growth forecast for next year by more than half and said it sees the risk of a recession as leaders struggle to contain the fiscal crisis.
Gross domestic product may grow 1.5 percent this year and 0.5 percent in 2012, the Brussels-based commission said today. It had earlier projected the 17-member region to expand 1.6 percent and 1.8 percent this year and next, respectively. In 2013, the economy may expand 1.3 percent, the commission said.
The euro-area economy is edging toward recession as governments are seeking ways to end the turmoil that has rattled global equity markets. In Italy, Prime Minister Silvio Berlusconi failed to convince investors that his country can slash the region’s second-largest debt burden. The commission said the risk of an economic contraction is "not negligible" and identified the fiscal crisis among the main threats.
"The outlook is unfortunately gloomy," Olli Rehn, the EU economic and monetary affairs commissioner, told reporters in Brussels today. "The forecast is in fact the last wake-up call. The recovery has now come to a standstill and there’s the risk of a new recession unless determined action is taken."
The euro region’s gross debt may average 90.4 percent of gross domestic product next year, up from 88 percent in 2011, today’s report showed. In 2013, government debt may average 90.9 percent. The region’s budget deficit may reach 4.1 percent of GDP this year before averaging 3.4 percent in 2012, according to the commission. That’s above the region’s 3 percent limit for budget shortfalls.
In Greece, government debt may reach 198.3 percent of GDP in 2012, up from an estimated 162.8 percent this year. Italy’s debt is seen at 120.5 percent of GDP this year and next.
Concern that countries may not be able to pay their debts has pushed up borrowing costs across Europe. Italian government bond yields widened to euro-era records versus German bunds as the sovereign-debt crisis spread to the region’s third-largest economy. Berlusconi agreed to step down after the approval of an austerity plan to tame the country’s debt burden.
Failure to contain the crisis that began with Greece led Portugal and Ireland to seek bailouts. At a meeting in Cannes, France, earlier this month, global leaders signaled concern that if the crisis keeps festering, the world economy could face a repeat of the chaos that followed the 2008 collapse of Lehman Brothers Holdings Inc.
Marco Buti, head of the commission’s economics division, said in the report that global leaders must "re-energize" joint efforts to help "steer out of the danger zone again." "There is no silver bullet to restore confidence at this juncture," Buti said in the introduction to the report. "What is needed is a bold and encompassing strategy that is implemented with a steady hand over the long haul."
The European Central Bank on Nov. 3 unexpectedly cut its benchmark interest rate by 25 basis points to 1.25 percent, with President Mario Draghi saying the economy faces "intensified downside risks." The central bank has purchased bonds of distressed nations to help contain the crisis.
The Frankfurt-based central bank said today that professional forecasters halved their growth estimates for next year. The euro-region economy may expand 0.8 percent in 2012 instead of a previously projected 1.6 percent, it said, citing the quarterly survey. In 2011, the economy may grow 1.6 percent.
"The ECB will hold out as long as it possibly can," Steven Barrow, head of Group of 10 currency strategy at Standard Bank Plc in London, said in an e-mailed note before today’s release. "For the moment, it can do that by slashing policy rates down to 0.5 percent, or lower."
With the economy cooling and consumers from Spain to Ireland hurt by budget cuts, companies may struggle to maintain their earnings growth. Daimler AG, the world’s third-largest maker of luxury vehicles, said on Oct. 27 that third-quarter earnings before interest and taxes dropped 19 percent, missing analysts’ estimates.
European unemployment unexpectedly increased in September, suggesting companies are under increasing pressure to cut costs. Schneider Electric SA, the world’s biggest maker of low-and medium-voltage equipment, on Oct. 20 lowered its 2011 earnings target for a second time in four months and said it may eliminate jobs on faltering demand.
Euro-region inflation may average 2.6 percent this year and 1.7 percent in 2012, the commission said. It had previously forecast annual consumer prices to rise 2.6 percent and 1.8 percent this year and next, respectively. Employment may rise 0.3 percent before stalling in 2012, it said.
Concern is mounting that sovereign-debt strains will spiral into a broader crisis for a global financial system that is more linked than ever and where half of Europe’s bank bonds are held by other lenders in the region. Commerzbank AG, Germany’s second-largest lender, swung to a third-quarter loss after writing down the value of its Greek debt holdings.
"The European sovereign debt crisis deepened in the third quarter of 2011," Chief Executive Officer Martin Blessing said on Nov. 4. "The uncertainty on the financial markets triggered by the sovereign debt crisis, together with the austerity policies in a number of European countries, is likely to exert an increasing drag on the real economy."
Some executives remain optimistic about global prospects. Guenter Blaschke, CEO of Rational AG, the world’s largest supplier of automated cookers to professional kitchens, said yesterday that he expects a "good economic environment" next year.
"Even during regional recessions, we have in the past been able to increase our sales," he said. "We take great care to remain as flexible as possible and able to react quickly should the overall environment deteriorate."
Savage recession looms as EC warns of slower growth in Europe
by Louise Armitstead - Telegraph
The threat of savage recession was piled on to deliberating European leaders amid warnings that the "clock is ticking" for them to resolve the debt crisis. As Italy and Greece struggled to agree new governments, the impact of the chaos was laid bare when the European Commission cut the eurozone's growth outlook next year from 1.8pc to 0.5pc.
Olli Rehn, Europe's economic affairs commissioner, said the economy was being sucked into a "vicious circle" of sovereign debt problems, vulnerable banks and collapsed spending. "Growth has stalled in Europe, and there is a risk of a new recession," he said. "GDP is now projected to stagnate until well into 2012."
Britain's economy will stagnate until the summer at least and faces the risk of a double-dip recession, the report said. In a heavy blow to Chancellor George Osborne, the Commission said Britain's economy will grow by just 0.7pc this year, 0.6pc in 2012 and 1.5pc in 2013. The figures are far lower that the 1.7pc, 2.5pc and 2.9pc growth forecast by the Office for Budget Responsibility (OBR) in March.
The Commission forecast Britain's public deficit will be reduced to 8pc of national income this year rather than 7.9pc predicted by the OBR and 7.8pc next year rather than 6.2pc. Economists estimate that Mr Osborne could have to raise an extra £20bn a year from spending cuts or tax increases to meet his targets.
Marco Buti, the Commission's head of economic affairs, warned that for the whole European Union "a deep and prolonged recession complemented by continued market turmoil cannot be excluded".
Fears for the economy are likely to further destabilise vulnerable eurozone countries and cause problems that Europe is woefully ill-equipped to deal with. Kraus Regling, head of the European Financial Stability Facility (EFSF), yesterday admitted that the turmoil in bond markets over the past 10 days has "probably" damaged the fund's ability to expand to €1trillion.
European leaders said they would boost the €440bn fund using leverage at the Brussels summit last month but have still failed to agree any details. One option is to back bonds of weak countries by insuring around 20pc the debt – but a collapse in confidence in recent days could mean that a far bigger part of the bonds would have to be backed.
Mr Regling told reporters: "The political turmoil that we saw in the last 10 days probably reduces the potential for leverage. It was always ambitious to have that number, but I'm not ruling it out." Officials hinted on Thursday that the fund – the lynchpin of Europe's rescue plans – may not be ready until the middle of next year.
Economists have called for the EFSF to be deployed to help reduce Italy's borrowing costs as early as Monday when Rome's next bond auction is scheduled. Mr Regling said: "Most agree we should first conclude our work on leveraging so the firewalls we are trying to erect are convincing. We are not eager to act next week, because we don't have the leveraging in place."
The markets turned their focus from Italy to France, which Standard & Poor's has threatened to strip of its AAA credit rating in the event of a eurozone recession. Unaffected by Paris's recently announced round of austerity measures, yields on France's benchmark 10-year sovereign debt hit 20-year highs.
Greece named Lucas Papademos as prime minister. The former vice-president of the European Central Bank (ECB), who is set to be sworn in at midday today, soothed nerves by committing Greece to implementing the economic reforms and austerity measures agreed at the Brussels summit.
European Commission president Jose Manuel Barroso and European Council president Herman Van Rompuy said that Mr Papademo's "workload will be extremely intense" but added that the "agreement to form a government of national unity opens a new chapter for Greece". Mr Papademos's appointment should clear the way for the release of the €8bn of international aid that was suspended pending an agreement on the new regime .
In Rome, Mario Monti, a former European Competition Commissioner, was lined up to replace Silvio Berlusconi – although the dogged prime minister refused to set a date to stand down.
After choppy trading, European markets closed marginally down on the day comforted by the signs of political concord in Greece and Italy. The Stoxx Europe 600 dropped 0.4pc, France's CAC 40 and the FTSE 100 in London slid 0.3pc each. In Germany, the DAX rose 0.7pc. Shrugging off EUropean worries the Dow Jones was up 1pc in late trade.
But Lee Hsien Loong, Singapore's prime minister, warned that "the clock is ticking" on international efforts to solve the crisis. He said: "I think all the [G20] ministers know that they have to do a lot more work. More action needs to be taken to make sure that the problem does not spread... which would have an implication for the whole world."
Italy: Past The Point Of No Return
by Megan Greene - Euro Area Debt Crisis
Yesterday Italy’s ten-year government bond yields soared well above 7%, the level beyond which Greece, Ireland and Portugal were all pushed into EU/IMF bailout programmes. Having been frozen out of the markets, Italy now faces a buyer’s strike. Its only possible options going forward are a bailout or a bail-in. Because Italy is too big to bail out, a debt restructuring seems inevitable.
The political drama in Italy has helped to push government bond yields to new euro area highs in recent days. The hope had been that once prime minister Silvio Berlusconi announced his intention to resign, borrowing costs would come down slightly. Instead, the markets have signaled that, even more than they dislike Mr Berlusconi, they dislike uncertainty over who will run Italy next and when the new government will be instated.
The only possible way Italy could regain market confidence at this point is if it swiftly implemented a package of austerity and structural reforms under a government with cross-party consensus and a strong, respectable leader, and this package immediately yielded results. This is nearly impossible. Austerity measures will immediately undermine economic growth in Italy, and a contraction of GDP will push the debt-to-GDP ratio up higher, making Italy look more insolvent.
Structural reforms must first be agreed (the letter Mr Berlusconi presented to EU leaders at the last summit on October 27th was short on structural reforms) and implemented. Even then, it will take years for the structural reforms to bite and support economic growth.
Even if borrowing costs for Italy did fall slightly, investors would seize the opportunity to dump their Italian government debt, forcing bond yields back up. Italy is past the point of no return. Is this an immediate problem?
Yes and no. Italy, unlike the other peripheral eurozone countries, has a relatively long debt maturity profile (just over 7 years). Italy could probably go for some time before it hits a month when it literally runs out of cash and would rather default on its debt than borrow at market rates. That being said, the longer Italy has to borrow at such punishing rates, the higher Italy’s debt stock will be in the future.
Prospects for an Italian bailout
There are only two real alternatives for Italy going forward: a bailout or a bail-in. With Italy’s debt stock at €1.9trn, it is hard to see where the eurozone could find a big enough bailout fund for Italy. The leveraged EFSF has clearly been grounded, with European and foreign investors alike shunning EFSF bonds. Besides, the EFSF is just a series of guarantees, and a bailout for a country with debt as high as Italy’s would need to be pre-funded to have any credibility.
A second source of bailout funding for Italy could be the IMF. The IMF currently has €291bn in global resources. Italy’s financing requirements in 2012 alone far exceed this at €325bn (debt rollovers plus the targeted budget deficit). Emerging Market (EM) countries, particularly China, might be convinced to participate in a bailout through the IMF by raising their IMF contributions. However, it is very unlikely the US would agree to increase its contribution while facing its own double dip recession. If the US does not boost its contribution, it will also veto EM countries boosting theirs so as to maintain the balance of power within the IMF.
A final option for a bailout is for the ECB to become a lender of last resort (LOLR) and monetize eurozone debt. This is unlikely for a number of reasons. First, it is against the treaties and would require a treaty change. Even if eurozone leaders were willing to accept a treaty change, it could not possibly be done in the time frame necessary. Second, the ECB has indicated over and over again that it does not want to be a LOLR.
In his first press conference following the ECB governing council’s November meeting, new ECB president Mario Draghi repeated ad nauseum that acting as a LOLR is not the ECB’s mandate and that the extraordinary measures the ECB has put into place (mainly referring to the Securities Markets Programme) are temporary and limited. Third, Germany is dead set against the ECB printing money to monetize debt. The German fear of hyperinflation is a social memory and looms large in the German psyche. It in very unlikely Germany would approve of the ECB becoming a LOLR.
Debt restructuring seems inevitable
In the absence of a bailout, Italy will be forced to undergo a debt restructuring, most likely in the form of voluntary Private Sector Involvement (PSI) similar to that already agreed for Greece. Just as the Greek PSI initially reduced privately held government debt by a paltry 21%, a relatively small haircut for Italy will probably be offered at first. This could well be followed by larger haircuts later on.
Even if Italy does restructure its debt, this would do little to solve its acute competitiveness problem. Here too, Greece could become a model for the larger country. Realistically, both countries face two options for regaining competitiveness and returning to growth: 1) austerity, internal devaluation and a decade of recession/depression or 2) abandon the euro, issue a national currency, allow it to depreciate significantly and regain competitiveness almost instantly (though leaving the eurozone would be extremely messy and painful in other ways).
Given these two choices, I think there will come a time when the Greek and Italian (and Portuguese and Spanish) governments will opt for the latter.
Italy's debt crisis: 10 reasons to be fearful
by Dominic Rushe - Guardian
The European debt crisis is getting ever more serious, and attention is moving away from Greece to one of the biggest – and potentially most explosive – economies in the world: Italy
Greece and Italy were the cradles of European culture: now they are threatening to drag the European Union to the grave. While Greece's fiscal woes were worrying, Italy's are monumental. Even Silvio Berlusconi, one of the great political survivors of our age, hasn't escaped this one. The Italian premier is out as the country's debts threaten to take down stock markets around the world. Here are the top 10 reasons to be concerned:
1. Italy is the eighth largest economy in the world and the fourth largest in Europe. Its gross domestic product (GDP) was over $2tn in 2010. Greece, Europe's other basket case, has a GDP of $305bn – an economy about the same size as Dallas, Fort Worth and Arlington in Texas.
2. The country is label-queen heaven – Ferrari, Prada, Armani etc – and a major player in utilities, telecoms and banking. But the recession has put a strain on its economy and a succession of pop-up governments have failed to tackle fundamental problems, including the massive pension debts owed its ageing population. Italy's debts now top $2.2tn, or 120% of gross domestic product.
3. The debt matters because Italy is one of the world's largest markets for government bonds. Fears that Italy cannot pay what it owes on government debt have driven rates on Italian bonds to over 7%. The levels are higher than bond prices reached in Ireland and Portugal before they had to be bailed out.
4. Higher bond rates should, in theory, make Italy more attractive to investors. But what it really indicates is that the country has lost the faith of the markets. It probably doesn't help that Berlusconi pretended to fall asleep during key meetings with European leaders. Credit rating agencies have already cut Italy's credit scores. Moody's said last month it had cut Italy's rating because of a "sustained and non-cyclical erosion of confidence in the wholesale finance environment for euro sovereigns," and said it had the country on watch for more cuts to come.
5. The speed at which government bond crises can escalate is startling: in April 2010, 10-year bond yields in Greece hit 7%; within a month they had reached 12%, prompting Greece's first bailout package. In Ireland, 10-year bond yield hit 7% in November 2010; a month later it had risen above 9%, triggering a bailout. In Portugal, yields hit 7% in November 2010; the bailout came in May.
6. Last month, at the crisis meeting of European leaders, Berlusconi promised wholesale reforms in Italy. His 14-page "letter of intent" included a commitment to raise the pension age to 67 by 2026; steps to make it easier for companies to fire workers; and asset sales and other measures to improve conditions for business. But Berlusconi's sketchy reforms failed to please anyone and met with both a political backlash and business scepticism.
7. "At this point, Italy may be beyond the point of no return," Barclays Capital said in a gloomy report this week. "While reform may be necessary, we doubt that Italian economic reforms alone will be sufficient to rehabilitate the Italian credit and eliminate the possibility of a debilitating confidence crisis that could overwhelm the positive effects of a reform agenda, however well conceived and implemented."
8. Analysts Capital Economics calculate that if Italy's cost of borrowing continues to soar, it will have to raise around €650bn ($880bn) for the next three years or so. If the government also received loans to provide its troubled banking sector with additional capital buffers, the bill could end up being closer to €700bn. Clearly it doesn't have that cash, so it will have to turn to the European financial stability facility (EFSF), the bailout fund that is backed by Euro big boys including Germany, France and – you've guessed it – Italy.
9. The EFSF doesn't have unlimited cash and a multi-year financing programme for Italy would seriously deplete funds. If it can't save Italy, who is next? The European Central Bank (ECB), possibly, but it has been unwilling to step in for fear of "moral hazard" – the risk that euro countries will not make any move to put their accounts in order if they believe a bailout is coming. Economists fear that matters will have to get even worse before the ECB steps in. If Italy has to leave the euro and go back to the lira, the whole eurozone is in jeopardy.
10. US officials keep saying that US banks have little "direct" exposure to Italy. But US institutions have been snapping up credit default swaps (CDSs), insurance against credit losses. The value of guarantees provided by US lenders on government, bank and corporate debt in troubled eurozone countries rose by $80.7bn to $518bn in the first half of this year, according to the Bank of International Settlements. One, admittedly small, firm – MF Global – has already gone belly-up in the US thanks to indirect bets on Europe. If Italy goes down in a disorderly default, it will make the Lehman Brothers collapse feel like a Roman holiday.
What happens next? The scenarios for Italy
by Peter Spiegel - FT
Markets have pushed Italy and the eurozone towards what many investors see as a tipping point, but European Union officials on Wednesday said they were waiting for Italy to decide on a new government rather than planning emergency measures to turn the tide.
The decision to stand firm appeared both a measure of the eurozone’s continued belief that only Italy itself can now change market sentiment – and a tacit acknowledgement the tools in the international arsenal have become increasingly limited.
The prospect of a technocratic government taking over quickly from a teetering Silvio Berlusconi to push through long-demanded economic reforms – coupled with returning order to Greece and beefing up their €440bn rescue fund – presented the best hope for turning around a darkening crisis.
"There is nothing that the European [leaders] can effectively do at this point," said Sony Kapoor, head of the economic consultancy Re-Define. "They have to let events happen in Italy." But if current plans do not work, the scenarios quickly become far more complicated:
1. The current plan: cut debt and spur growth now
EU officials and the majority of independent analysts agree that Italy’s economic fundamentals, while not rosy, are far better than those of Greece or other eurozone countries in full-scale bail-outs. Italy’s debt levels are high, but its annual deficits are small, its banking sector is sound, and its overall economy big and diversified.
As a result, reforms that can immediately cut the country’s debt burden and spur economic growth could have a powerful effect on its ability to dig out of the current hole. Making sure Italy moves forward on plans to do both is the reason officials pushed Rome to accept both EU and International Monetary Fund monitors.
Mujtaba Rahman, an analyst at the Eurasia Group, said the Italian panic had been made worse by Greece and fights over reforming the rescue fund, the European financial stability facility. "Focusing on addressing those pieces may be enough to massage sentiment in the right direction ... in combination with more technical oversight from the IMF to address Italy’s internal issues."
A letter sent by EU inspectors ahead of their arrival Wednesday, and obtained by the Financial Times, shows their mission intends to be intrusive. Brussels is asking for a specific list of state-owned assets Rome can sell in order to raise €5bn per year for debt reduction. The letter also asks for measures "over and above" the privatisation plan.
Potentially more contentious, inspectors wrote that they believe Italy would no longer hit budget targets for 2012 and 2013 and asked for Rome to come up with "additional measures" to balance its budget by 2013.
EU officials have reason to hope such measures can work. Ireland, which had solid economic fundamentals before a banking crisis dragged it into a €85bn bail-out last year, has seen its bond yields cut almost in half – from above 14 per cent in July to close to 7.6 per cent earlier this week – after two quarters of better-than-expected export growth.
2. Provide a precautionary line of credit
This was offered to Mr Berlusconi at the Group of 20 summit in Cannes last week, but was turned down. Such a line of credit would likely come from the IMF, something it does with regularity for countries that are solvent but struggling to raise cash. Last month, the EFSF was given similar powers and there is now talk it could step into the breach.
Essentially, the EFSF or IMF would give Italy a limited amount of credit – anywhere from €50bn to €80bn – with a firm set of conditions attached. Doing so would lend credibility to the Italian reform plan and solve the most immediate problem: Italy’s inability to borrow money at sustainable rates.
But the move could further spook investors, convincing them Italy’s problems were worse than originally believed. In addition, even at eye-popping levels, the aid may not be enough. Italy must raise €300bn next year. "That €50bn will get used up in three months or so," said Mr Kapoor. "Then what?"
3. If all else fails: a full-scale bail-out
If Italy proves unable to return to the public markets with a credit line, the next step would be a bail-out that would take Rome out of the bond market altogether.
If such a plan were to follow previous models, it would be a three-year programme where EU and IMF lenders would carry the weight of Italian debt payments until confidence returned so Italy could service its own debts.
The problem is Italy’s size. While a small country like Greece needs about €130bn to cover borrowing needs for three years, Italy would need that much to cover just six months. All told, the EFSF, which started with €440bn, now only has about €250bn left to lend – a number that in an Italian bail-out suddenly gets cut to €110bn, since Italy contributes €139bn to the fund.
Italy would therefore have to rely heavily on the IMF. But IMF officials said they only had about $400bn on hand – or about €300bn – barely enough to last Italy through next year. Developing countries such as Brazil would undoubtedly object if the IMF dedicated that much money to another eurozone rescue.
4. Or, a takeover by the European Central Bank
Some eurozone governments, led by France, have argued that the ECB must become the zone’s lender of last resort in order to stop the run on peripheral sovereign bonds. If it were to guarantee all Italian debt, the ECB’s unlimited firepower – it can literally print money – could give it the power to buy every Italian bond and ensure Rome could borrow at low rates for the foreseeable future.
Central banks in the US and Britain already do this routinely. But Germany has long objected to so-called "monetary financing" – using central banks to fund government spending – and ensured it was prohibited in the Lisbon Treaty, which governs EU institutions.
Leading voices in Berlin, including the German president, have already objected to limited ECB bond purchases, and there has been no sign Berlin would back down. But because Germany has only two votes on the ECB board, German opposition could be overcome. "You could end up with a divided ECB with the majority saying we’re facing an existential crisis," said Mr Kapoor.
But some worry that even the bottomless pockets of the ECB may not be enough to stop the panic if it were to grip the €1,900bn Italian bond market by the throat. "The situation has deteriorated so dramatically a large-scale asset buying by the ECB would not necessarily be a panacea," RBS analyst Alberto Gallo said in a conference call with investors on Wednesday. "I do not think the ECB on its own could bring back the market to the point before Italy succumbed."
What Comes Next for Troubled Italy?
by Florian Diekmann and Christian Teevs - Spiegel
Italy appears to be moving toward political stability with reports that respected banker Mario Monti may become the country's next prime minister. But can he succeed in reversing years of political stagnation? If he doesn't, Rome's problems could spell the end of the European currency union.
It was Wednesday, the day after the political fate of Italian Prime Minister Silvio Berlusconi appeared to have been sealed, and people were astonished -- and deeply concerned. Many had felt that the financial markets would cheer the approaching departure of the Italian premier. But they were sadly mistaken. Instead of declining, the interest rates Italy must pay for new sovereign bonds rose sharply on the day after Berlusconi announced he would soon resign. Yields on 10-year bonds were intermittently as high as 7.45 percent. Portugal and Ireland turned to the bailout fund for assistance when their bonds reached that level in 2010.
Even after the announced departure of Il Cavaliere, Italy -- it became clear this week -- remains the biggest threat to the euro zone. The question of whether the currency area will survive hinges on the country, the euro zone's third-largest economy. Italy's debts exceed €1.9 trillion ($2.58 trillion), which is 120 percent of the country's annual economic output. Only in Greece is the debt-to-GDP ratio higher.
Short-term spikes in bond interest rates, of course, are not a huge problem. But should investors continue to demand record returns, the Italian budget will face tremendous burdens. Next year alone, Italy will have to refinance €300 billion in maturing bonds. Furthermore, the Italian economy is also sluggish and expected to grow by only 0.5 percent this year. By comparison, the German economy is expected to end 2011 with 3 percent growth.
Crucial for Survival
Politically, at least, Italy appeared to be working toward a solution on Thursday. Many of the Wednesday market jitters came about due to a lack of faith that Berlusconi would indeed swiftly depart as promised. But throughout Thursday, support grew for respected economist Mario Monti to lead an interim government. Italian President Giorgio Napolitano nominated Monti, a former European competition commissioner, as senator for life on Wednesday and said that far-reaching economic reforms could be passed as early as this weekend. Both moves appeared to pave the way for Monti to step into the premiership sooner rather than later -- a prospect that sent interest rates on Italian bonds plummeting on Thursday.
Still, even if Monti's arrival cheers the markets -- and eliminates the need for new elections, which many feared would delay reforms even further -- Italy's economic and debt problems remain real. Rome's progress toward solving those problems is crucial for the survival of the European common currency.
So what happens next? There are three possible scenarios.
Scenario One: Italy Recovers on Its Own
Monti is able to quickly gain the backing of a broad range of political parties in Rome and creates a stable national unity government made up of economic experts. He forcefully implements the austerity goals promised -- but not delivered -- by Berlusconi, including raising the retirement age to 67, privatizing government-owned businesses and pushing through significant cutbacks in the public sector. In addition -- and of equal significance -- credibility would be restored to the Italian government.
The above scenario would allow Italy to quickly regain the confidence of the financial markets, the rates on new debt would continue to retreat to a tolerable level, and the acute danger would be averted.
At least Italy's fundamentals are encouraging. The economy is highly developed and diversified, the budget deficit is relatively small and the banks are healthy. "The commotion in the markets is greatly exaggerated," says Jens Boysen-Hogrefe of the Kiel Institute for the World Economy. Besides, says Jürgen Matthes of the Cologne Institute for Economic Research (IW), "in recent years, Italy has learned to cope with high debts and low growth rates."
In 1995, Italy had a debt-to-GDP ratio of 121.5 percent, higher even than it is today. By 2007, it had reduced its mountain of debt to 104 percent of GDP, even though the economy only grew at a snail's pace. "Italy's budget is geared toward weak growth," says Boysen-Hogrefe.
The European Commission anticipates a budget deficit of 2.4 percent for next year. "Without the consequences of the 2008/2009 recession, Italy would even have reduced its debt load, as it did in the years prior," says Boysen-Hogrefe. When adjusted for interest, the government even has a budget surplus. Italy has promised a balanced budget for 2013, which would mean that at least its mountain of debt would not continue to grow.
Scenario One: Italy Muddles Through
The hopes that everything will improve are based primarily on Berlusconi's departure. But what happens if the new government does not meet expectations? In light of the weak growth of the last 15 years and the country's fossilized political structures, it is conceivable that Italy will still need several more years to solve its problems.
In that case, the country could be reliant on its partners in the euro zone and on the International Monetary Fund (IMF). Indeed, the IMF reportedly offered Berlusconi a modest credit line worth €50 billion at the G-20 summit in Cannes, France, last week. Such short-term aid could remove Italy from the financial markets' line of fire for a few months. That, in turn, would enable the country to avoid punitive interest rates on its bonds, should investors remain wary.
Berlusconi initially turned down the offer in Cannes. But if bond yields remain at or near 7 percent -- instead of the 4 percent they commanded last year -- Italy could be tempted to accept the aid. It is, however, unclear whether such a loan would reassure investors, or whether it could even heighten mistrust. Many experts, in any case, are skeptical about this solution. "Interim financing can only work if the markets are convinced that, within a few months, Italy can refinance itself independently in the long term," says Boysen-Hogrefe.
Either way, persistently high bond yields would cause significant problems for Italy. The European Commission has warned that the rate rise jeopardizes the country's growth prospects because a loss of investor confidence doesn't just affect the government, but also companies. For them, it becomes increasingly difficult to borrow new money. In the worst case, this could lead to a credit crunch. Weak growth could quickly turn into a recession.
The risks would also increase in the euro zone in such a scenario, and the possibility of Spain, Belgium and even France becoming infected would grow. Italy could also see itself needing additional loans from its euro-zone partners, which would require German taxpayers to provide guarantees.
Scenario Three: Italy Goes Under
Should Italy prove unable to convince markets of its fundamental economic health and follow the route that Greece has, it would most likely spell the end of the currency union. And the danger certainly exists. The €440 billion European Financial Stability Facility (EFSF) -- even now that it has been enlarged -- is simply not big enough to prop up Italy. At the moment, the EFSF has €250 billion available, with around €200 billion already committed elsewhere.
Even if the EFSF is leveraged to €1 trillion, as euro-zone leaders agreed to pursue at the end of October, financing Italy would be virtually impossible. In the worst cast, the country would face an uncontrolled bankruptcy, with catastrophic consequences for the financial system and the global economy. "The international financial system would collapse," warns Jürgen Matthes of the Cologne Institute for Economic Research. A series of other countries could be threatened by bankruptcy, with Spain, Belgium and possibly even France being the next likely candidates.
Banks throughout Europe would be on the verge of collapse, and even German lenders could only be saved through extreme intervention -- by the European Central Bank or the German government. But then yields on German government bonds could also increase drastically.
The third scenario would also be devastating for the global economy. In fact, says Boysen-Hogrefe, the consequences would probably be even worse than those of the 2008 Lehman Brothers bankruptcy.
The only good thing about his worst-case scenario is that all players are aware of the disastrous consequences were it to become reality. Despite all speculation over what happens next for Italy, it seems clear that euro-zone leaders will do everything in their power to stabilize the country.
France plots eurozone 'breakaway group'
by Bruno Waterfield - Telegraph
France is drawing up plans to create a breakaway organisation of eurozone countries with its own treaty, parliament and headquarters – a move that could significantly undermine the existing European Union. The proposal would see a formal "union within a union" created, but would lead to a significant deterioration in Britain's influence in Europe.
David Cameron is drawing up urgent plans to stop Britain being "railroaded" into agreeing to decisions taken by the new eurozone bloc. France and Germany are understood to want to strengthen the union between eurozone countries with new taxes and legal measures to stop nations borrowing and spending too much in future.
Weaker countries such as Greece could even be barred from the new eurozone, under radical suggestions from some of those involved in discussions over the plan. It comes amid growing concerns that France could be the next nation to become embroiled in the single currency crisis. Gordon Brown, the former prime minister, said France was "in danger of being picked off by the markets in the coming weeks and months".
Angela Merkel, the German Chancellor, has warned Mr Cameron that unless he accepts unconditional changes to the Lisbon Treaty a split will take place, leaving Britain isolated and in a voting minority within the EU.
"She explicitly told Cameron that if there was no treaty change at the level of the 27 EU members then others will peel off, which is not what she wants," a senior EU diplomat told The Daily Telegraph. According to diplomatic notes, Mr Cameron is pushing for "concrete and effective mechanisms" to "ensure essential economic interests of non–participating member states are fully protected".
Friday is expected to be another crucial day in the ongoing crisis as Italian politicians vote on plans to cut public spending and delay retirement. European leaders are hoping the vote will be passed, paving the way for Silvio Berlusconi to be replaced as prime minister.
Greece on Thursday finally installed a new prime minister – Lucas Papademos, a former central banker – and the country is expected to unveil its national unity government today. EU diplomatic sources indicate that Britain is fighting France and Germany to resurrect the "Ioannina compromise", which would allow a blocking minority of countries to stop the new eurozone vanguard bloc pushing decisions through the EU.
The mechanism, named after a meeting of EU foreign ministers in the Greek city 17 years ago, was abandoned by Tony Blair during negotiations for the Treaty of Nice in 2000. A Government spokesman said: "Discussions about possible further changes to the EU treaties are at a very early stage. But we are clear that any changes would need to protect the rights of those countries in the EU but outside the eurozone, and ensure that any additional enforcement measures would not apply to the UK as a result of our opt-out from the single currency." Any proposals to change the EU treaties must also be agreed by all member states."
Jean-Claude Piris, a former senior EU official, has come out of retirement to "help the eurozone in the current crisis" by working on a blueprint for the new union and its separate institutions. Mr Piris is the "eminence grise'' of EU legal texts and is credited with the Lisbon Treaty, the failed EU Constitution and their predecessors, the Nice, Amsterdam and Maastricht treaties.
He has argued that it would be "far better" to create "an avant-garde group, probably based on the current 17 members of the euro area" than attempt treaty change. "Willing euro members would conclude an additional treaty compatible with international and EU law,’’ he wrote in a paper circulated last week. ''This would contain additional obligations for them, as well as a definition of the organs and rules that would govern their supplementary co-operation in the best way possible."
The emphasis by Mr Piris on "willing" members and ''additional obligations’’ has stoked rumours, denied in Paris, that Nicolas Sarkozy, the French president, is trying build a smaller eurozone without the highly indebted or bailed-out countries of Greece, Ireland, Portugal or Italy.
Speaking yesterday, Mrs Merkel insisted that Germany would not support a smaller eurozone. "We have a single goal and it is to stabilise the eurozone as it is today, to make it more competitive, to make progress in balancing budgets," she said.
Michael Meister, the Bundestag finance spokesman for Mrs Merkel’s Christian Democrats, said "such a shrinking process would be deadly for Germany". He added: "It would be a deadly development for an export country like Germany.’’
French, Germans explore idea of core euro zone
by Julien Toyer and Annika Breidthardt - Reuters
German and French officials have discussed plans for a radical overhaul of the European Union that would involve establishing a more integrated and potentially smaller euro zone, EU sources say.
French President Nicolas Sarkozy gave some flavor of his thinking during an address to students in the eastern French city of Strasbourg on Tuesday, when he said a two-speed Europe -- the euro zone moving ahead more rapidly than all 27 countries in the EU -- was the only model for the future.
The discussions among senior policymakers in Paris, Berlin and Brussels go further, raising the possibility of one or more countries leaving the euro zone, while the remaining core pushes on toward deeper economic integration, including on tax and fiscal policy. A senior EU official said changing the make-up of the euro zone has been discussed on an "intellectual" level but had not moved to operational or technical discussions, while a French government source said there was no such project in the works.
Such steps are also opposed by many EU countries, whose backing would be needed for any adjustments to the bloc's treaties, making them anything but a done deal. "This will unravel everything our forebears have painstakingly built up and repudiate all that they stood for in the past sixty years," one EU diplomat told Reuters. "This is not about a two-speed Europe, we already have that. This will redraw the map geopolitically and give rise to new tensions. It could truly be the end of Europe as we know it."
Nonetheless, the Franco-German motor has generally been the driving force in steps forward for European integration. To an extent the taboo on a country leaving the 17-member currency bloc was already broken at the G20 summit in Cannes last week, when German Chancellor Angela Merkel and Sarkozy both effectively said that Greece might have to drop out if the euro zone's long-term stability was to be maintained.
But the latest discussions among European officials point to a more fundamental re-evaluation of the 12-year-old currency project -- including which countries and what policies are needed to keep it strong and stable for the next decade and beyond -- before Europe's debt crisis manages to break it apart.
In large part the aim is to reshape the currency bloc along the lines it was originally intended; strong, economically integrated countries sharing a currency, before nations such as Greece managed to get in. "France and Germany have had intense consultations on this issue over the last months, at all levels," a senior EU official in Brussels told Reuters, speaking on condition of anonymity because of the sensitivity of the discussions.
"We need to move very cautiously, but the truth is that we need to establish exactly the list of those who don't want to be part of the club and those who simply cannot be part. "In doing this exercise, we will be very serious on the criteria that will be used as a benchmark to integrate and share our economic policies."
One senior German government official said it was a case of pruning the euro zone to make it stronger. "You'll still call it the euro, but it will be fewer countries," he said, without identifying those that would have to drop out. "We won't be able to speak with one voice and make the tough decisions in the euro zone as it is today. You can't have one country, one vote," he said, referring to rules that have made decision-making complex and slow, exacerbating the crisis.
Speaking in Berlin on Wednesday, Merkel reiterated a call for changes to be made to the EU treaty -- the laws which govern the European Union -- saying the situation was now so unpleasant that a rapid "breakthrough" was needed. "The world is not waiting for Europe," she said in comments that focused on treaty change but hinted at more fundamental shifts. "Because the world is changing so greatly, we have to make a mental decision to find an answer to the challenges."
From Germany's point of view, altering the EU treaty would be an opportunity to reinforce euro zone integration and could potentially open a window to make the mooted changes to its make-up. EU officials have told Reuters treaty change will be formally discussed at a summit in Brussels on December 9, with an 'intergovernmental conference', the process required to make alterations, potentially being convened in the new year, although multiple obstacles remain before such a step is taken.
While the two-speed Europe referred to by Sarkozy is already reality in many respects -- and a frustration for the likes of Poland, which hopes to join the euro zone -- the officials interviewed by Reuters spoke of a more formal process to create a two-tier structure and allow the smaller group to push on.
"This is something that has been in the air for some time, at least in high-level talks," said one EU diplomat. "The difference now is that some countries are moving forward very quickly ... The risk of a split, of a two-speed Europe, has never been so real."
In Sarkozy's vision, the euro zone would rapidly deepen its integration, including in sensitive areas such as corporate and personal taxation, while the remainder of the EU would be left as a "confederation," possibly expanding from 27 to 35 in the coming decade, with enlargement to the Balkans and beyond. Within the euro zone, the critical need would be for core countries to coordinate their economic policies quickly so that defences could be erected against the sovereign debt crisis.
"Intellectually speaking, I can see it happening in two movements: some technical arrangements in the next weeks to strengthen the euro zone governance, and some more fundamental changes in the coming months," the senior EU official said. But he cautioned: "Practically speaking, we all know that the crisis may deepen and that the picture can change radically from one day to another."
France and Germany see themselves as the backbone of the euro zone and frequently promote initiatives that other euro zone countries reject. The idea of a core, pared-down euro zone is likely to be strongly opposed by the Netherlands and possibly Austria, although both would be potential members. "This sort of thinking is not the direction we want to go in. We want to keep the euro zone as it is," said a non Franco-German euro zone diplomat.
Britain, which is adamantly outside the euro zone, is also opposed to any moves that would create a two-speed Europe, or institutionalize a process even if it is already under way. "We must move together. The greatest danger we face is division," Britain's deputy prime minister, Nick Clegg, said during a visit to Brussels on Wednesday.
"That is why, while the United Kingdom fully supports deeper fiscal integration within the euro zone to support monetary union, we would not wish it to become a club within a club. "To retreat from each other now would be to leave ourselves isolated in extremely tempestuous times."
Sorry, there is no euro break-up plan – yet
by Ambrose Evans-Pritchard - Telegraph
Very quickly, I have grave reservations about the Reuters story claiming that top German and French officials have had "intense consultations" on plans to reshape or "prune" the currency bloc, reducing it to a manageable core. The Brussels press corps do not believe it. Nobody seems to know which German official is briefing behind the scenes that "you’ll still call it the euro, but there will be fewer countries."
The claims do not remotely reflect the stated position of Chancellor Merkel and President Nicolas Sarkozy. Merkozy might like to see Greece tossed to the wolves. That is a different matter.
There is a drive for a core Europe or "Avant-Garde" that pushes ahead with closer union, but that is mostly directed against the UK and other members of the awkward squad. Reuters seem to have conflated two separate issues.
The reality is that EU leaders are still unwilling to contemplate an orderly break-up of monetary union, or to deploy the system’s dwindling reserve of credibility to prepare for this traumatic moment. To the extent that the Reuters story catches one vein of thought in EU capitals, it is about forcing weak states to leave EMU. This is the worst possible outcome. It can only set off a chain reaction, ultimately engulfing France. At that point the whole eurozone would spiral into a catastrophic depression – if it is not already. Germany itself would be ruined.
My own proposal – like that of Hans-Olaf Henkel, the former head of Germany’s BDI industry confederation – has long been for a radically different kind of break-up. Germany and its satellites should leave, bequeathing the euro, the ECB and other EMU institutions to a Latin union led by France. The euro debt contracts of the south would remain intact. (It is crucial that France stays in the southern bloc, otherwise the instant devaluation of the south would be too great, and France’s banks would blow up on Italian debt)
If conducted skilfully, the revalued Teutonic Thaler could be held by exchange and capital controls at a 30pc premium for long enough to stabilise the two systems. Ultimately each side would get what it wants: Germany could enjoy the stronger currency it needs; the south would restore labour competitiveness without having to go through a decade of grinding deflationary slump. This itself would reduce the risk of defaults. I suspect that within five years, the Latin half would prove to be the more dynamic bloc.
Obviously Germany, Holland etc would have to recapitalise banks to absorb the shock of 30pc FX losses on their Club Med bonds. The banking system might have to be nationalised. So what? This would be much cheaper than the trillions now needed to prop up EMU’s rotten edifice. It addresses the core problem of north-south currency misalignment within EMU that lies behind the whole crisis. Unfortunately, neither Berlin nor Paris seem ready to think along these lines. It would require a complete purge of the political elites in both countries.
Given this strategic fact – and given the risk that Europe will take us all hurtling into disaster – the authorities must instead step up to the plate and deploy the ECB as a lender of last resort to halt the debt spiral. (Yes, the ECB may be incapable of playing this role, since it has no sovereign indemnity. That is a risk. All possible outcomes are by now fraught with danger.)
This must be backed by a broader switch away from 1930s Laval-Bruning liquidationist and contraction policies. There is no justification for allowing real M1 deposits to contract across most of the eurozone – and to plunge in the south – as has occurred over recent months. For a monetarist central bank, the ECB is remarkably insouciant about money.
The EU must slow the pace of fiscal contraction and launch a monetary blitz to lift the south out of chronic depression. A 5pc nominal GDP growth target for euroland for as long as it takes would do the trick. I believe central banks have the capability to deliver such result.
Let me be clear, this is not my preference. It would better for greater Germany to leave EMU. But given the evidence so far that Germania has no intention of taking such a course, it must instead drop its opposition to the sort of radical reflation stimulus so obviously needed to save monetary union and avoid a savage slump. What Germany cannot continue to do is to refuse to leave EMU, and refuse to reflate. This is not a policy. The rest of the world is entirely entitled to make its irritation known.
Merkel’s Greek Strategy Risks Backfiring as Euro’s Exit Routes Are Mapped
by Simon Kennedy - Bloomberg
Germany and France’s drive to force Greece to honor its euro commitments risks backfiring on Chancellor Angela Merkel and President Nicolas Sarkozy. A week after the currency’s guardians declared for the first time that countries can be ejected from the 17-nation bloc, U.S. stocks tumbled on concern German politicians are already creating exit chutes for the weakest members.
The sell-off suggests Europe’s crisis is spiraling into a new stage as investors bet on which countries are most likely to quit the euro, starting with Greece. The risk is that this will make it harder for debt-laden countries to convince investors they can get their finances in order and for policy makers such as Merkel, Sarkozy and European Central Bank President Mario Draghi to bolster the euro’s defenses.
"This is a dangerous phase," Neil MacKinnon, global macro strategist at VTB Capital in London and a former U.K. Treasury official, told Bloomberg Television’s "On the Move" with Francine Lacqua yesterday. "All of a sudden, we’re talking about the future of monetary union in its current format."
U.S. stocks dropped late Nov. 9 as news broke that members of Merkel’s ruling Christian Democratic Union party plan to debate a motion next week allowing countries to leave the euro region. The Standard & Poor’s 500 Index fell as much as 1 percent. In Europe, the Stoxx 600 Index has lost 2.6 percent in the past two sessions. U.S. stocks rose yesterday after Standard & Poor’s confirmed its AAA rating on France.
Merkel and Sarkozy ignited speculation that the euro area could contract near midnight on Nov. 2 in Cannes, France, when they warned outgoing Greek Prime Minister George Papandreou that a planned referendum on his country’s latest bailout must serve as a ballot on whether Greece wants to stay in the euro. "The referendum will revolve around nothing less than the question: does Greece want to stay in the euro, yes or no?" Merkel said with Sarkozy beside her.
While the ploy worked and Papandreou shelved the referendum, it undermined the message of the euro’s founding treaty that membership was "irrevocable" -- a line Sarkozy and Merkel had stuck to in the two years since the crisis broke out.
Sarkozy and Merkel opened a "Pandora’s Box," said Stephen King, chief economist at HSBC Holdings Plc in London, this week. He was referring to the Greek myth in which the first woman on earth disobeys orders of the gods by opening a jar and unleashing evil around the world, leaving only hope behind.
Countries unable to play by the euro’s rules may now have to leave the bloc, upending the assumption that "once in the euro a country could never escape," King said in a note to clients. Now "what’s true of Greece may now also be true of Italy."
Italian 10-year bond yields surged to a euro-era high of 7.46 percent Nov. 9 as investors questioned the ability of its lawmakers to restrain the euro-region’s second-largest debt load after Greece. While the yield slipped to 6.89 percent yesterday, the crisis showed signs of spreading to France. Credit default swaps on the euro region’s second-largest economy rose eight basis points to a record 204 yesterday, CMA prices showed.
Some politicians are already working on a plan to push out errant members that can’t get their finances in order. Merkel’s Christian Democratic Union may adopt a motion at an annual party congress next week to allow euro members to exit the currency area, Norbert Barthle, the ranking CDU member on the German parliament’s budget committee, said.
The drive was dismissed by other members of Merkel’s party. Germany will resist any attempt to reduce the euro to its strongest members, the parliamentary finance spokesman for the CDU said yesterday. "Such a shrinking process would be deadly for Germany," Michael Meister said in a telephone interview.
Any pan-European appetite for a re-drawing of the euro’s boundaries may be on show Dec. 9 when leaders hold another summit, this time to discuss deepening euro-area convergence, tightening fiscal discipline and strengthening economic ties. "They might be talking about an exit clause for the euro area after Greece," said Daniel Gros, director of the Centre for European Policy Studies in Brussels.
It wouldn’t be the first time the strategy of Merkel and Sarkozy has ended up hurting rather than calming markets. Thirteen months ago they agreed at the French resort of Deauville that private investors must contribute to future European bailouts. The resulting bond-market selloff played a part in Ireland and Portugal subsequently requiring bailouts.
Any change in composition would validate the opinions of academics and investors including Harvard University’s Martin Feldstein and Mohamed El-Erian, chief executive officer of Pacific Investment Management Co. Feldstein, who warned in a 1998 paper that monetary union would prove an "economic liability," and El-Erian both say ensuring the euro’s existence may require a smaller, stronger bloc.
A report last month from the London-based Economist Intelligence Unit, titled "After Eurogeddon?," said any fracturing would likely leave the euro in the hands of a strong northern core featuring Germany, Austria, Belgium, Finland, Luxembourg, the Netherlands, Slovakia, Slovenia and Estonia.
While France would suffer from a likely surge in the new euro it would remain a member because its monetary union with Germany is fundamental to France’s political and economic interests, the report said. Greece would be first to leave followed eventually by Portugal, Ireland, Italy, Spain, Malta and Cyprus, it said.
"If they push out weaker countries and the euro stays, it would represent a smaller number of countries, so the currency should be stronger," said Nicola Marinelli, who oversees $153 million at Glendevon King Asset Management in London. "But we don’t know the knock-on effects that could come from a country leaving so there would be a period of great uncertainty and weakness."
European leaders will still do their utmost to keep the euro-zone in its current form, said Marc Chandler, chief currency strategist at Brown Brothers Harriman & Co. in London. "Rather than break-up, the solution for Europe’s crisis will be more integration," he said. "European officials, including Germany and France, in word and deed recognize the important of preserving the euro zone as currently constituted."
A break-up could threaten a repeat of the Great Depression, HSBC’s King said in an analysis last month. For the exiting country, the banking system could face collapse, capital controls would be needed to stop citizens moving savings out of the country and companies would face default. On top of that, inflation would spiral, technical problems such as updating computer codes would be required and the accompanying departure from the European Union would leave it subject to trade tariffs, he said.
Turmoil could also spread to other debt-strapped nations, featuring bank runs "in countries perceived to be at risk of leaving," Deutsche Bank AG chief economist Thomas Mayer told clients this week. King says with banks in pain and restricting credit, the ECB would have little option but to inject a vast amount of liquidity and print money to buy potentially unlimited quantities of bonds.
"The seismic shift in European convictions presented in Cannes could come back to haunt its authors," said Mayer.
The euro is being held together only by fear
by Jeremy Warner - Telegraph
There has been a lot of "thinking the unthinkable" over the past week. If the euro is ultimately unsustainable, why not just face up to reality and let this grand exercise in political hubris go?
Would the consequences really be quite as bad as conventional analysis makes out? These questions need deconstructing. The announcement of a referendum last week by Greek (then) prime minister George Papandreou prompted German Chancellor Angela Merkel and French premier Nicolas Sarkozy to ask in exasperation whether Greece wanted the euro or not.
Their intention was to frighten the Greeks into submission, and it worked. Papandreou is gone, and a government of national unity is being formed under the fully signed up eurocrat Lucas Papademos. Berlin and Paris have got their way. But in threatening effective expulsion, they also broke an unspoken taboo; they admitted that countries can opt out if they want to. In so doing, they invited speculation on just such an outcome.
Since then, the waters have been further muddied by the suggestion that German and French officials are already working on plans for a two-speed Europe, involving closer union for a smaller euro core. Those unable or unwilling to meet the requirements would be thrown out.
In any case, the principle has now been openly acknowledged. Divorce is possible. The difficulty occurs because for the time being none of these countries actually wants to leave. Even the Greeks seem to have decided, for now, that getting out is not a solution. The same is broadly true of Ireland, Portugal, Spain and Italy. In none of these countries is there a credible political force that advocates exit.
This in itself may be symptomatic of a dangerous divorce between political elites and growing popular sentiment, but that's a story for another day. Right now, they all seem to be falling over themselves to take their medicine.
It's not just the markets that demand Italy suspends the Byzantine infighting of its political system and form an unelected government of technocrats to enact the pain. There seems to be much appetite for it among Italians, too.
Unfortunately, it's most unlikely to result in a sustainable euro. The internal devaluation demanded of these countries is going to take years to deliver results. That's years of austerity, and years of nil or negative growth for no certain gain in competitiveness. Europe seems to be condemning itself to a Japanese-style lost decade, and very likely something worse.
If something cannot be sustained, then eventually it won't be. Nobody can tell you exactly when the single currency might unravel, but plainly the consequences are going to be far more damaging if it is in an ad hoc, disorderly fashion than if it is planned and massaged.
At the moment, the euro is held together only by the fear of what might happen if it all falls apart. The omelette has already been made. It cannot now be unscrambled, or at least not without cost.
Not everyone shares this view. In a recent report, the Centre for Economic and Business Research, said these fears were exaggerated. The CEBR puts the loss at a comparatively small 2pc of eurozone GDP. The short-term pain would be considerable, the CEBR admits, but growth would soon resume at a much faster pace than otherwise. As for the UK, after five years it would be better off than if the euro holds together.
Without knowing the CEBR's methodology it's hard to assess how credible these forecasts are, but they look too optimistic to me. Furthermore, it all depends on what form of break up eventually occurs. An orderly break up which could be restricted to one or two outriders might not be so bad, but since that's not under serious contemplation, an ultimately more chaotic, involuntary and wide-ranging break up at a later stage seems more likely.
There are no precedents for such an event, but if the collapse of Lehman Brothers, a relatively small bank, was enough to trigger a worldwide recession, just think what mass sovereign default would do. Furthermore, Lehman's collapse would have transmogrified into a depression but for the policy action taken. In fighting the downturn, nations effectively bankrupted themselves, leading to the present, second leg of the crisis. They cannot repeat the same trick.
The criminality of what's going on is that no serious thought is being given to how Europe can get out of the mess it has created at the least possible cost. Instead the focus is all on how to prop up a now manifestly failed endeavour. Unfortunately, that makes more calamitous outcomes much more probable.
Italy Bond Market as Euro Proxy
by Landon Thomas Jr. - New York Times
A day after panicky investors drove Italian bond rates well above 7 percent, reviving fears that the euro zone was heading toward a break-up, the market calmed somewhat on Thursday after Italy managed to attract strong buying interest for a shorter-term bond offering. Also helping buoy the market were rumors that the European Central Bank had stepped up its purchase of Italian bonds.
But a calmer market should not be confused with an optimistic one. Investors are still deeply worried about Italy’s mounting political and debt financing woes. Even the seeming rallying point on Thursday — Italy’s ability to sell out an offering of 5 billion euros in one-year bonds — had a dark side. The interest rate was 6 percent, up from 3.5 percent only a month ago.
In fact, investors and analysts say, the very depth and sophistication of Italy’s 1.9 trillion euro ($2.6 trillion) bond market, the third-largest in the world after the United States and Japan, has made it a proxy of sorts for the euro zone’s deeper problems. Those include the possible exit of Greece from the euro and Germany’s resistance to assuming a larger financial burden in rescuing weaker economies.
Investors have been dumping Italian bonds that they own, and ramping up their negative bets by selling Italian bond futures as well. The Italian bond market is the only large market in the euro zone outside of Germany to offer investors the ability to buy or sell futures contracts. That has allowed many investors to use Italian futures to place bearish bets on Italy, and as a proxy for the broader euro zone itself.
"The futures market for Italian bonds has become the main conduit now for all investor angst with regard to the euro zone," said Yra Harris, a trader at Praxis Trading on the Chicago Mercantile Exchange.
In what has become a highly volatile trading environment, investor fears can shift sharply, turning sellers into buyers, especially if it becomes clear that the European Central Bank has started buying bonds. That is why, after Italian 10-year yields touched a dangerously high level of 7.4 percent on Wednesday, word that the bank had started buying the bonds sent yields as low as 6.7 percent on Thursday.
Market jitters were also calmed by indications that Italy was moving closer to appointing a new government with a revamped legislative initiative, making it more likely that the European Central Bank will follow through with additional Italian bond purchases. And further soothing came from the resolution of the Greek political drama, with the appointment of Lucas Papademos, the former vice president of the European Central Bank, as the country’s new prime minister.
Still, European officials are keeping the pressure on Italy. At a news conference Thursday, Olli Rehn, the European Union commissioner for economic and monetary affairs, insisted that Italy’s meeting its fiscal targets and adopting structural reforms was a "sine qua non for restoring confidence in the Italian economy."
At the root of this confidence drain is the substantial size of debt that Italy must raise from local and foreign investors next year alone: about 350 billion euros. That is about the size of Greece’s total debt.
Over the years, Italy has become a very efficient debt-raising machine, with more than 50 percent of its financing needs met by local banks and investors. But a substantial amount still must come from foreign investors, which in the past have largely been major European banks.
Now these banks are selling their positions to avoid the prospect of having to book losses from their reduced value. And if they are continuing to participate in new bond auctions, as with Thursday’s one-year offering, they are demanding much higher interest rates.
Meanwhile, the negative betting continues. According to officials at Eurex, Europe’s main derivatives exchange, the market for Italian bond futures has increased substantially of late, to as much as one billion euros a day. That is more or less the same size as the market for buying and selling Italian bonds directly.
Many people entering into these futures trades are doing it for hedging purposes or to protect their portfolios if Italy defaults. But as broader worries about Greece are added to the concern that Italy may no longer be able to finance its debt burden, traders have started to sell Italian bond futures directly — a bet that the euro zone itself might collapse and that Italian bonds will continue to lose value.
Despite all the bad news, those negative bets remain a very risky undertaking. Analysts point to the fact that the European Central Bank still has considerable firepower and can move markets sharply by buying Italian bonds, as it did Thursday. But the purchases have been small compared with the total debt outstanding, and some say they believe the bank should publicly commit to buying far more, or even to back Italy’s entire debt.
There is disagreement, however, over whether the bank will be allowed to drastically step up its bond purchases. The central bank’s charter requires it to focus on price stability in Europe, not an individual sovereign market’s stability.
Some argue that the central bank should not be diverting its view from its main purpose, but others say the purchases are clearly allowed. There is a provision of the governing treaty that allows the central bank to buy or sell market instruments if it furthers the bank’s primary mission of maintaining price stability.
James Savage, a fellow at the United States Institute of Peace and author of a book about the creation of the euro zone, said there is no cap on how far the central bank can go under that provision, and he said he could see it allowing the bank to back Italy’s bond market, if needed. "There’s no prohibition; there’s no level; there’s no constraint," Mr. Savage said. "If price stability is your goal, it’s really a matter of how you can argue that your policies are leading to that outcome."
As it purchases government bonds, the central bank has been taking steps to try to remove any possibility of causing inflation through that action. The bank has taken in greater deposits from banks alongside its bond purchases, though it is not clear the bank needs to do that to justify further purchases.
If European officials concluded that the central bank could not substantially increase its role in Italy without a change in its mission, that would require approval from each member of the European Union, undoubtedly a slow and possibly politically unfeasible process.
Economists also emphasize that, if the amount of interest Italy pays on its debt is excluded, the country is running not a deficit but a surplus, one that is expected to be 2.5 percent of gross domestic product in 2012, the highest of any major developed economy.
But the positive spin goes only so far. In the view of Peter Bofinger, a German economist who advises the finance ministry in Berlin, the longer Germany insists on segregating the debts and deficits of individual euro area countries as opposed to adding them all together across the euro zone, the sooner such distinctions will become meaningless.
"When Italian interest rates go above 7 percent, that turns a liquidity crisis into a solvency crisis," he said. In other words, if rates continue to increase, Italy might have to exit the debt markets as Greece and Ireland did, and resort to a bailout. "Europe either stands united and survives," he said, "or stays divided and falls."
S&P Roils Markets With Erroneous French Rating Downgrade
by Catarina Saraiva and John Detrixhe - Bloomberg
Standard & Poor’s roiled global equity, bond, currency and commodity markets when it sent and then corrected an erroneous message to subscribers suggesting France’s top credit rating had been downgraded.
The benchmark Stoxx Europe 600 Index extended its decline to 1.5 percent to 234.11 and French 10-year bond yields surged as much as 28 basis points to 3.48 percent, the highest level since July. The euro pared gains and U.S. equities briefly dropped after the mistaken announcement. Commodities erased gains before resuming increases after S&P affirmed France’s AAA rating in a later statement.
"It clearly raises issues about internal systems and controls," said Christopher Whalen, managing director of Institutional Risk Analytics, a Torrance, California-based bank- rating firm. "The onus is on them to be careful and it’s troubling. Whether you’re a broker dealer or a rating agency, everything you say has to be very carefully considered because of the weight that they carry."
A downgrade of France’s credit rating would affect the rating of the European Financial Stability Facility, the bailout fund for struggling euro member countries that has funded rescue packages for Greece, Ireland and Portugal partially through bond sales. If the EFSF has to pay higher interest on its bonds, it may not be able to provide as much funding for indebted nations.
S&P’s erroneous message was put out at 3:57 p.m. Paris time. The company sent a release at 5:40 p.m. Paris time saying the message was incorrect and affirming France’s rating. Martin Winn, a S&P spokesman in London, didn’t immediately reply to a request for additional comment after forwarding the rating notes.
The euro rose 0.6 percent to $1.3620 at 1:28 p.m. in New York after paring its gain to $1.355. The S&P 500 Index (SPX) dropped as much as 0.1 percent to 1,227.7 after the erroneous announcement and the S&P GSCI Total Return Index of 24 commodities weakened 0.4 percent before gaining 0.9 percent.
France Angry at Credit Rating Gaffe
The French finance minister has reacted angrily to a credit-rating gaffe by Standard and Poor's. The agency accidently sent out an email suggesting that France had lost its triple-A rating. Many are asking how the firm could have made such an embarrassing slip-up at a time when markets are especially jittery.
First Greece, then Italy and now France? That, it would seem, was the message of an email erroneously sent out by Standard & Poor's to several of its customers on Thursday. According to the message's subject line, France had lost its AAA rating -- an eventuality which could plunge the country into the kind of difficulties currently being experienced in Italy. It was only one-and-a-half hours later that the mistake was corrected.
According to a statement by S&P, a technical glitch resulted in the automatic message being sent to subscribers of its Internet site Global Credit Portal saying that France's rating had been changed. S&P emphasized that this was not the case and that France was retaining its AAA rating with a stable outlook. The company said that anyone who clicked on the link in the email, which featured the subject line "DOWNGRADE," would have seen that France's rating had not changed.
The New York Stock Exchange temporarily fell as a result and yields on French 10-year sovereign bonds jumped 27 base points to 3.46 percent. The euro also lost ground against the dollar.
French Finance Minister François Baroin called the mistake "shocking" and demanded an immediate investigation into the incident by European and French regulators. The French stock-market regulator AMF reacted by launching an investigation. The European Union regulator ESMA and the US Securities and Exchange Commission are also expected to look into the incident.
The gaffe could hardly have happened at a worse time. In recent weeks there has been speculation that France could lose its AAA rating as a result of French banks' exposure to Greek debt. In mid-October, Moody's had warned that the country's AAA rating could be in jeopardy unless the government made an effort to get its finances under control during the next three months.
Furthermore, market nerves are particularly frayed at the moment given uncertainty over the political situation in Greece and the risk that the euro crisis could engulf Italy, the third-biggest euro-zone economy. For French President Nicolas Sarkozy, who is running for reelection next year, it is vitally important that France keep its triple-A rating.
"Can you believe this?" one unnamed French official told the Financial Times. "This is not going to please people. … In the situation we are in at the moment, you can't play around like this." "This was the first day when we got the feeling that France could be infected by the crisis," a French trader told the newspaper Le Nouvel Observateur, referring to the fact that French bond yields had jumped by over 25 percentage points.
"Given how important these sovereign ratings have become and how on edge markets are, for S&P to accidentally send out a note like this borders on comical," said Michael Church, head of an investment-management firm, in remarks to the Wall Street Journal.
Criticism of Big Three
One former S&P analyst told the Wall Street Journal that the fact that an alert was ready in the system suggested that the rating agency could be in the middle of a review of France's creditworthiness.
The gaffe came on a day when the European Commission had forecast that the French economy would only grow by 0.6 percent in 2012 and urged France to take further steps to make sure its budget deficit gets under the EU limit of 3 percent of gross domestic product in 2013. Finance Minister Baroin insisted that the country was already doing enough to cut its deficit, however.
The incident is unlikely to improve the reputation of the "big three" rating agencies. Many European politicians have accused S&P, Moody's and Fitch of exacerbating Europe's debt crisis through their downgrades, and there have been repeated calls for the current rating-agency system to be reformed.
In October, S&P downgraded Spain to AA- from AA. The country was also downgraded by Moody's and Fitch. In September, the big three had previously downgraded Italy. S&P currently gives the country an A rating.
Jefferson County, Alabama, Votes to Declare Biggest Municipal Bankruptcy
by William Selway, Martin Braun and Margaret Newkirk - Bloomberg
Jefferson County, Alabama, commissioners voted 4-1 to file the largest U.S. municipal bankruptcy after reaching an impasse over concessions with holders of $3.14 billion of bonds. JPMorgan Chase & Co., which arranged most of the debt to fund a sewer renovation, will likely take the biggest loss in the process, which begins with a hearing 10 a.m. local time tomorrow.
A provisional agreement with creditors that commissioners approved in September included $1.1 billion in concessions and called for sewer-rate increases of as much as 8.2 percent for the first three years. The county, which encompasses the state’s largest city, Birmingham, couldn’t get signed commitments from creditors, Commission PresidentDavid Carrington said today.
In addition, the 25-member legislative delegation for the county was unable to unite behind bills needed to implement the tentative settlement. "We’ve reached that last resort," said Commissioner Joe Knight. "We could continue and keep kicking this can down the road, but I think the people of Jefferson County have had enough." Governor Robert Bentley, a Republican, said he was disappointed by the commission’s vote.
Limiting the Pain
"The Jefferson County sewer-debt crisis has been an impediment to economic growth in the state, and the bankruptcy filing will now be an even greater challenge to overcome," he said in a statement. "Now we must rise to this new challenge, move forward to bring economic growth and stability to the Birmingham region, and do everything in our power to limit the impact of this decision."
The county’s efforts to negotiate a definitive settlement were frustrated by the recent sale of sewer debt to investors who didn’t want to restructure the bonds under the terms of the September agreement, according to the bankruptcy filing. Justin Perras, a spokesman for JPMorgan, said the bank had not wanted bankruptcy. JPMorgan held more than $1.2 billion of the county’s sewer debt as of May, according to a document provided by Bentley’s office in September.
"We offered very substantial financial concessions to make the deal happen while keeping sewer rates within the parameters proposed by the county," he said in an e-mail. "While we’re disappointed by the county’s decision to file, we will continue to work toward a fair and reasonable solution."
Cities in Trouble
The vote by officials in Alabama’s most populous county occurred about a month after Pennsylvania’s capital of Harrisburg sought court protection citing millions in overdue bond payments tied to a trash-to-energy incinerator. On Aug. 1, Central Falls, Rhode Island’s smallest city, sought court protection, citing pension costs it can’t afford. The municipality listed almost $21 million in general-obligation debt outstanding.
Even with the Chapter 9 filings, local-government bond defaults declined to $949 million in the first nine months of 2011, about one-third the pace of 2010 and 10 percent for corporate debt, according to the Distressed Debt Securities Newsletter, published by Miami Lakes, Florida-based Income Securities Advisor Inc. Municipal bankruptcies are rarer than corporate failures. Jefferson’s is the 11th this year. In 2010 there were 13,713 corporate Chapter 11 filings, according to a website maintained by the Administrative Office of the U.S. Courts.
The Jefferson filing eclipses the previous record, set in 1994 by Orange County, California. That county, which was driven into bankruptcy by $1.7 billion in losses on interest-rate bets, had about $2.2 billion in debt outstanding, according to a June 1995 financial report. The Alabama filing might reignite concerns among investors over defaults in the $2.9 trillion U.S. municipal bond market.
"It’s going to create attention-grabbing headlines, and the question is how retail investors react," Peter Hayes, a managing director at BlackRock Inc., the world’s largest asset manager and the owner of $95.6 billion of municipal bonds, said before today’s decision. Bankruptcy had loomed over the county for more than three years. Commissioners sought to spare residents from ballooning fees needed to pay off the debt that financed a sewer project rife with corruption.
The crisis intensified in March when the state’s highest court struck down a tax on wages that generated $70 million annually for the general fund. The county put employees on unpaid leave, closed courthouses and scuttled road repairs after losing the levy that provided about a quarter of its revenue.
The size of sewer-fee increases became a hurdle because residents can ill afford higher costs, according to Commissioner George Bowman, who represents one of the county’s two poorest districts. Almost 70 percent of sewer users are in the two districts with the lowest average incomes, he has said.
Jefferson County’s system serves about 478,000 people through 144,000 accounts, according to a June report from John Young, the court-appointed receiver who runs the system. The county’s median household income is about $45,000 a year, according to U.S. Census Bureau data. Many sewer customers reside in Birmingham, where the figure is about $32,000. The average residential wastewater bill is $37.74 a month, according to Young.
Banks and Bonds
The bankruptcy leaves banks such as JPMorgan, investors and the bond insurers Financial Guaranty Insurance Co. and Syncora Guarantee Inc. facing hundreds of millions of dollars in losses. Michael Corbally, a spokesman for Syncora, declined to comment.
In addition to sewer bonds, Jefferson County has about $1 billion in other bond debt: $200 million of general obligation bonds and $814 million of school-construction bonds, according to its bankruptcy petition. Jefferson now must show a federal judge that it can’t pay its bills and then draw up a plan for meeting obligations, which the court may reduce. Unlike corporate cases, creditors can’t try to seize or sell off county assets, and the court can’t appoint a trustee to run the county.
Municipalities have more leverage with creditors under Chapter 9 of the U.S. Bankruptcy Code than corporations have when reorganizing debt in Chapter 11 protection, said Marc Levinson, a lawyer who represented Vallejo, California, when that city went bankrupt. A judge has limited authority to force a municipality to take specific actions, Levinson said.
Limited Court Power
"About the only thing a judge has the power to do is dismiss the case," Levinson said. The crisis in Alabama arose when investors dumped Jefferson county’s bonds as the subprime mortgage-market meltdown sent ripples through Wall Street. Jefferson’s floating-rate securities were coupled with interest-rate swaps, a money-saving strategy pitched by banks that backfired. As credit markets convulsed in 2008, the county’s interest costs soared. When banks demanded early payoffs of the bonds, the county defaulted.
The debt deals also were rife with political corruption, leading the cost of the sewer project to soar as it was built during the 1990s. Former commission president and Birmingham Mayor Larry Langford, a Democrat, was convicted of accepting bribes in connection with the financing.
Two former JPMorgan bankers are fighting Securities and Exchange Commission charges that they made $8 million in undisclosed payments to friends of commissioners to secure the bank’s role in the deals. In 2009, JPMorgan agreed to a $722 million settlement with the SEC.
The financings arranged under Langford converted almost all the county’s sewer debt into securities that carried interest rates that periodically reset, a strategy promoted by Wall Street as a way for borrowers to save money using short-term interest rates on debt that didn’t mature for decades. The swaps paired with the bonds were meant to hedge against adverse changes in the rates.
Exposed to Crisis
That strategy left the county exposed in 2008, when the credit crisis pushed up municipal lending rates. As banks began hoarding capital, the market froze for auction-rate bonds, a type of security used by Jefferson, and the county had to pay penalty interest rates.
After some bond insurers incurred losses on subprime- related securities, threatening the credit ratings they used to guarantee other Jefferson debts, investors in 2008 dumped the sewer securities on banks that had agreed to act as buyers of last resort. That triggered contractual requirements for the county to pay off $850 million of the debt in four years instead of the 30 or 40 under the original agreements, according to government records.
The demands pushed the county into defaulting. The uncertainty that has reigned since then has led some businesses, politicians and residents to be thankful for any route that would bring the saga to a close.
Losing It on the Home Front
by - BusinessWeek
The housing crisis just keeps grinding on. Home prices fell in three-quarters of U.S. cities in the third quarter, by double digits in some places, according to the latest data from the National Association of Realtors. The median U.S. house price, $164,500, is now 28 percent below its 2006 peak and about where prices stood in Feb. 2003. Fewer people plan to buy a home over the next six months, according to the Conference Board. And another survey of homeowners finds that nearly as many think of owning a home as a “nightmare” as consider it an “American Dream.”
It’s hard to put a happy face on that — but boy, do the Realtors try. NAR President Ron Phipps, who runs his own brokerage in Warwick, R.I., says: “Existing-home sales are little changed from the second quarter but are notably higher than a year ago.” The Realtors’ Housing Affordability Index, he says, is near its record high. “For people with secure jobs, good credit and long-term plans, today’s conditions will be remembered as a golden opportunity to enter the housing market.”
That well-qualified statement pretty well answers itself. Even if you have a job, chances are you don’t consider it too “secure.” Long-term plans? See previous. The NAR’s affordability index seems designed to make every day a buying day, as financial blogger Barry Ritholtz has explained: “from 1989 - 2009, the NAR showed housing as ‘unaffordable’ for just one month.”
This eagerness to call a housing bottom is nothing new. My colleague Mark Gimein, writing for Slate’s The Big Money in April, 2010, noted that the Realtors were trumpeting “stabilizing” and “steadying” prices at a time when the percentage of people who couldn’t pay their mortgages was climbing in the worst-hit markets. At the time, fewer than half of U.S. cities were reporting a price increase. NAR Chief Economist Lawrence Yun said back in February, 2010, that the “price recovery process appears durable;” in fact, the following spring prices rose in less than a third of cities.
The Realtors aside, many people are into the process of resetting their psychology about wealth and real estate. For a reminder of the magical thinking that pumped up the housing bubble, read this piece in today’s New York Times about one homebuyer’s road to ruin. It’s all there: the “what we can afford” price climbing with no relationship to income; pressure to buy before prices go up further; banks willing to lend over the purchase price; refinancing to support a bloated lifestyle. It’s hard to believe it ever happened, unless you’re still trying to climb out of the hole.
New recession threatens the globe as debt crisis grows
by Ambrose Evans-Pritchard - Telegraph
Europe's escalating debt crisis has cast a black shadow over the world's fragile recovery, threatening to tip large parts of the global economy into a deep downturn and even outright recession.
The OECD's index of leading indicators for China, India, Brazil, Canada, Britain and the eurozone have all tipped below the warning line of 100, with the pace of the decline in Europe exceeding the onset of the Great Contraction in early 2008. Professor Simon Johnson, a former chief economist at the IMF, rattled nerves earlier this week by warning the world is "looking straight into the face of a great depression".
The grim data is coming thick and fast. Japan's machinery orders fell 8.2pc in September as the post-Fukushima rebound lost steam and the delayed effects of the super-strong yen began to bite. Export orders have been declining for eight months. "Outright contraction is possible in the quarters ahead," said Mark Cliffe from ING.
Exports in the Philippines dropped 27pc in September, the sharpest fall in two years. Korea's exports have showed sharply, caused by a 20pc slide in shipments to Europe. Manufacturing has been contracting for the past three months.
Christine Lagarde, the IMF's chief, warned in Asia that "there are dark clouds gathering in the global economy. Countries need to prepare for any storm that might reach their shores". She said "adverse feedback loops" are at work as financial stress and economic woes feed on each other.
China's carefully managed soft landing has turned uncomfortably hard, with ripple effects through the commodity markets. Spot iron-ore prices have dropped 30pc since July to $126 a tonne. Copper prices have fallen 20pc since August. Barclays Capital said the risk of contagion to China has become serious. The bank is monitoring the country's "key high frequency data" for early warning signs of the sort of sudden crash in metals demand seen during the Lehman crisis.
China had the firepower to respond to the 2008 crisis with blitz of credit that helped lift the whole world out of slump, a feat that cannot easily be repeated if there is a second shock. The IMF said loans have doubled to almost 200pc of GDP, including off-books lending. This is an unprecedented level of credit growth, twice the intensity of the Japanese bubble in the late 1980s.
The authorities are trying to deflate the excesses slowly with higher interest rates and reserve ratios. This is proving painful. Yao Wei from Societe Generale said prices of new residential property fell 14% in October. Railway investment collapsed by 40% as the insolvent railway ministry struggled to cope with $300 billion of debt. Highway construction dropped 2pc.
Europe is in a deeper, more intractable crisis. Industrial output buckled in September with falls of 4.8pc in Italy, 2.7pc in Germany, and 1.7pc in France from a month earlier as the effects of the debt crisis – as well as fiscal contraction and prior monetary tightening – finally hit with a vengeance.
EU commissioner Olli Rehn slashed growth forecasts from 1.6pc to 0.5pc next year, warning "that recovery has now come to a standstill and there's the risk of a new recession unless determined action is taken". This did not stop Brussels sending a letter to Italy calling for yet more fiscal cuts to meet it is balanced budget target by 2013.
"It is imposing pain for pain's sake, and it is going to cause creditors to collect even less on their Club Med debts than if austerity were abandoned. Even in the early 1930s they weren't as bad as this," said Charles Dumas from Lombard Street Research.
Humayun Shahryar from the hedge fund Auvest said the eurozone faces a "major economic collapse", perhaps with double-dgit falls in GDP. "European banks are massively over-leveraged and almost every one is worthless if you mark to market. This is going to be worse than 2008 because they have run out of bullets. The sovereign states are not strong enough to stand behind the banks," he said.
Professor Johnson said the EU authorities had made a serious mistake by raising capital ratios for banks to 9pc rather than forcing them to raise fresh capital. "That will lead to a further contraction of credit."
Banks have already taken drastic steps to cut their loan books rather than raise money in a hostile market, earmarking over €700bn for the next year. There will be knock-on effects for the rest of the world. European banks account €2.5 trillion cross-border loans to emerging markets.
In the US, the economy has held up better than feared so far but faces a fiscal shock early next year. Tax write-offs have pulled capital expenditure forward into late 2011, flattering the picture. Payroll taxes will rise automatically from 4.2pc to 6.2pc in January. Dumas said the combined fiscal squeeze could be as much as 2pc of GDP, heavily "front-loaded" in the early months. "Sharp recession is likely," he said.
"The credit spigot has been turned off in the US," said Chris Whalen from Institutional Risk Analytics. "Almost every bank is still running down its loan book, so we are facing a slow motion credit-crunch."
Fiscal and monetary stimulus has disguised the underlying sickness in the debt-laden economies of the West over the past two years. This heavy make-up has at last faded away, exposing the awful visage beneath.
It is a delicate moment. The risk of a synchronised slump in Europe, the US and East Asia is bad enough. What is chilling is to face such a possibility with the monetary pedal already pushed to the floor in the US, UK and Japan.
Worse yet is to do so with Europe spiralling into institutional self-destruction, allowing its debt crisis to metastasize because EMU has no lender of last resort. That is an unforced error we could do without.
Europe pushes Italy into the abyss
by Ambrose Evans-Pritchard - Telegraph
It has taken three trading days since the failure of the G20 summit to detonate the explosive charge on Italy's €1.9 trillion (£1.6 trillion) bond market, the world's third-largest stock of public debt.
Europe's purported "firewall" to safeguard Italy does not, in fact, exist. The EU's vague plans to leverage its EFSF rescue fund to €1 trillion have come to nothing. Investors could see at once that plans to use the fund as a "first loss" bond insurer concentrates risk, dooming France's AAA rating and accelerating contagion to the core.
The European Central Bank (ECB) has been buying Italian bonds, but too slowly to stop the debt spiral. The ECB's new chief, Mario Draghi, kicked off his term with a blunt warning that it would be "pointless" for the bank to try to cap the yields of struggling debtors for long. It was an invitation for frightened investors to dump their bonds.
With almost nothing in place to halt contagion, the market verdict has been swift and brutal. Capital Economics said "the Rubicon may have been crossed" after yields on 10-year Italian bonds smashed through 7pc on Wednesday. Clearing house LCH.Clearnet has raised margin requirements once and will almost certainly do so again. Italy is effectively shut out of global capital markets.
Rome will not be able to roll over some €300bn in debt next year and will spiral into "disorderly default" unless EU authorities immediately face up to the enormity of the crisis. "It is a panic. Rome is burning. Governments need to stop the fire spreading," said Jennifer McKeown, the group's Europe economist.
Wider contagion was alarmingly clear as yield spreads on French debt rose to a post-EMU record of 146 basis points over Bunds. French lenders have $416bn (£261bn) of exposure to Italian debt of various kinds. The two Latin nations are joined at the hip.
"It is obvious what needs to be done," said Tim Congdon at International Monetary Research. "The ECB must engineer a 'boomlet' by purchasing €1 trillion of bonds – boosting the M3 money supply by 10pc – to end all the agony. This means that Germany must put up with 4pc to 5pc inflation for while, but is that such a disaster? If they want to save the euro, they have to give some hope to the peripheral countries."
Hans Redeker from Morgan Stanley said the ECB must cap yields at 6.5pc by soaking up an "unlimited supply" of Italian bonds if necessary. "At the end of the day, we all know what the ultimate solution is going to be. They are going to have to monetise," he said.
This does not seem likely yet. On Tuesday, Germany's two ECB members warned that the bank must not stray into debt monetisation or start quantitative easing, though there are at last signs that parts of the German establishment are starting to think creatively. The heads of the country's five top institutes – the "Five Wise Men" – have together called for a debt pact to break the "vicious circle of an intertwined sovereign debt crisis and a banking crisis".
The radical plan proposes a €2.3 trillion fund to enable joint bond issuance on a chunk of debt. This is a bitter pill for Germany but is the only way to avoid an "uncontrolled collapse of monetary union" or recourse to the "sin" of unlimited debt purchases by the ECB.
The Wise Men said their idea is a "very different animal" from eurobonds – anathema to the Bundestag – because the shrinking fund would be wound down gradually. It would not be a form of fiscal union. Chancellor Angela Merkel shot down the idea, warning it would require an EU treaty change and amendments to the German constitution. She stuck to her mantra that the solution is for Italy to carry out reforms and meet its austerity target.
The European Commission stepped up its surveillance demands, calling for a list of state assets to be sold and "additional measures" to balance the budget by 2013 if the economy goes into a deeper downturn.
Italy is now being forced to tighten fiscal policy into a deepening recession – against the advice of the International Monetary Fund – repeating the formula that has failed in Greece and closely resembles the final debacle of the 1930s Gold Standard.
The country is almost certainly in recession already, the result of combined monetary and fiscal tightening across the eurozone earlier this year. Real M1 deposits turned negative for the whole region over the summer, with dire rates of contraction in Italy and Club Med. Milan consultants Ref Ricerche believe Italy's economy will shrink all through 2012 and 2013 in what amounts to a full-blown depression. This will itself cause debt dynamics to metastasize.
The strange feature of the crisis is that Italy is not fundamentally insolvent. Public debt has been stable for several years at about 120pc of GDP. The country has a primary budget surplus. Household debt is low at 42pc of GDP. Net household wealth is €2.3 trillion, higher in per capita terms than in Germany. Combined public and private debt is under 260pc, lower than in Holland, France, Britain, the US and Japan.
The core problem is not Italy's debts but the 40pc loss of labour competitiveness against Germany over the past 15 years. This has left the country trapped inside EMU with misaligned currency, choking growth.
It is hard to see how the resignation of Silvio Berlusconi makes any difference. He has run one of Italy's most stable post-war governments. Elections are likely to throw up a splintered political mix, with gains for the Left but no one bloc able to put together a strong coalition. The nation remains bitterly divided on redundancy law and "firm-level" wage bargaining. The trade unions remain militant.
Stephen Lewis from Monument Securities said the search for some sort of "Grand Plan" or mega-fund to save the euro is an evasion of the North-South intra-EMU currency misalignment corroding the whole project. "Whatever they do, the underyling economic divergence will still exist. It may be that there is no solution and that it would be better to finance an orderly break-up of the euro," he said.
There are already hints of this comimg from Brussels, with reports of "intense consultations" between German and French officials on reshaping or "pruning" the currency bloc, reducing it to a manageable core.
"You'll still call it the euro, but there will be fewer countries," said a German official. Veteran EU watchers say the leaks appear to be a heavy-handed attempt from certain quarters in Berlin to force austerity compliance in southern Europe. Such forms of diplomacy usually blow up in the face of the authors.
Italy is sinking into depression, and that's before any act of default
by Jeremy Warner - Telegraph
Here we go. The European economy seems already to have gone over the edge of the cliff, and that's before any of the eurozone 17 has technically defaulted. This morning's industrial production figures from Italy were a disaster, with output down a staggering 4.8pc in September.
OK, so Italian IP tends to be quite volatile – the previous month was sharply up. But regrettably, it's part of a pattern, only the worst in a bad bunch. In the same month, French industrial production was down 1.7pc and German industrial output by 2.7pc. The "mild recession" predicted by Mario Draghi, the European Central Bank's new president, last week, may already be a very serious one.
Italy managed successfully to offload €5bn of one year bonds onto the markets this morning – albeit at a penalty interest rate – but this was never going to be the real test of continued market appetite for Italian paper. That comes next week, with the auction of longer dated five year bonds. The longer the maturity, the greater the perceived risk of default, so it's going to be tough.
The biggest part of Italy's problem in terms of market credibility is its politics. There are undoubtedly big problems with the economy, but Italy is not Greece. On some measures, Italian output is larger than that of the UK, household debt is low and there's plenty of hidden wealth. But it is weighed down by checks and balances, and its politics are of byzantine complexity, making decisive corrective action next to impossible.
Some believe this could be corrected by Silvio Berlusconi's immediate resignation (which is possible by the end of the week, though I'll believe it when I see it), and the installation of a technocrat government which is nominated by the president, but not elected. This would not be a first for Italy. It happened once before in the early 1990s, when Carlo Ciampi presided over a so called "technocratic government".
To have an election is judged to take too long, and in any case would likely result in a government too weak to push through the desired reforms. There is a sense in which the opposition doesn't in any case want power. What's required is too painful to allow for popular support.
With democracy suspended, the technocrat government could rapidly impose the sort of changes demanded by the eurocrats and the markets. These would go well beyond fiscal fiddling with wealth taxes and entitlements. Root and branch supply side reform, making business start ups easier and so on, would have to be imposed.
Will it do the trick? I doubt it. Supply side reform, even assuming it can be delivered without sparking social and political revolt, takes years to deliver growth, and Italy hasn't got that luxury. This is the sort of thing that should have been done ages ago, not now in the midst of a crisis. Italy needs to grow to service and pay down its public debts, but everything so far prescribed seems to work in the opposite direction.
Astonishingly, a letter sent by EU inspectors ahead of arriving in Italy demands further austerity on top of that already agreed, this because lack of growth means there is now no chance of Italy meeting its 2012 and 2013 budget targets. Italy is being required to chase its tail down into the abyss.
This is all wrong. Unless a more enlightened approach is adopted soon – it may already be too late – it's game over for Europe. The eurozone seems to be condemning itself to depression.
Why Italy’s days in the eurozone may be numbered
by Nouriel Roubini - FT
With interest rates on its sovereign debt surging well above seven per cent, there is a rising risk that Italy may soon lose market access.
Given that it is too-big-to-fail but also too-big-to-save, this could lead to a forced restructuring of its public debt of €1,900bn. That would partially address its "stock" problem of large and unsustainable debt but it would not resolve its "flow" problem, a large current account deficit, lack of external competitiveness and a worsening plunge in gross domestic product and economic activity.
To resolve the latter, Italy may, like other periphery countries, need to exit the monetary union and go back to a national currency, thus triggering an effective break-up of the eurozone.
Until recently the argument was being made that Italy and Spain, unlike the clearly insolvent Greece, were illiquid but solvent given austerity and reforms. But once a country that is illiquid loses its market credibility, it takes time – usually a year or so – to restore such credibility with appropriate policy actions.
Therefore unless there is a lender of last resort that can buy the sovereign debt while credibility is not yet restored, an illiquid but solvent sovereign may turn out insolvent. In this scenario sceptical investors will push the sovereign spreads to a level where it either loses access to the markets or where the debt dynamic becomes unsustainable.
So Italy and other illiquid, but solvent, sovereigns need a "big bazooka" to prevent the self-fulfilling bad equilibrium of a run on the public debt. The trouble is, however, that there is no credible lender of last resort in the eurozone.
One is urgently needed now. Eurobonds are out of the question as Germany is against them and they would require a change in treaties that would take years to approve. Quadrupling the eurozone bailout fund from €440bn to €2,000bn is a political non-starter in Germany and the "core" countries.
The European Central Bank could do the dirty job of backstopping Italy and Spain, but it does not want to do it as it would take a huge credit risk. It also cannot do it, as unlimited support of these countries would be obviously illegal and against the treaty no-bailout clause.
Thus, since half of the European financial stability facility’s resources are already committed to Greece, Ireland, Portugal and to their banks, there is only about €200bn left for Italy and Spain. Attempts have been made to use financial engineering to turn this small sum into €2,000bn.
But the leveraged EFSF is a turkey that will not fly, because the original EFSF was already a giant collateralised debt obligation, where a bunch of dodgy, sub-triple-A sovereigns try to achieve, by miracle, a triple-A rating via bilateral guarantees. So a leveraged EFSF is a giant CDO squared that will not work and will not reduce spreads to sustainable levels.
The other "turkey" concocted by the EFSF was supposed to be a special purpose vehicle where reserves of central banks become the equity tranche that allows sovereign wealth funds and the Bric countries to inject resources in a triple-A super senior tranche. Does this sound like a giant sub-prime CDO scam? Yes, it does. This is why it was vetoed by the Bundesbank.
So, since the levered EFSF and the EFSF SPV will not fly – and there is not enough International Monetary Fund money to rescue Italy and/or Spain – the spreads for Italian debt have reached a point of no return.
After a patchwork of lending facilities are cobbled together, and found wanting by the markets, the only option will be a coercive but orderly restructuring of the country’s debt. Even a change in Italian government to a coalition headed by a respected technocrat will not change the fundamental problem – that spreads have reached a tipping point, that output is free-falling and that, given a debt to GDP ratio of 120 per cent, Italy needs a primary surplus of over 5 per cent of GDP just to prevent its debt from blowing up.
Output now is in a vicious free fall. More austerity and reforms – that are necessary for medium-term sustainability – will make this recession worse. Raising taxes, cutting spending and getting rid of inefficient labour and capital during structural reforms have a negative effect on disposable income, jobs, aggregate demand and supply. The recessionary deflation that Germany and the ECB are imposing on Italy and the other periphery countries will make the debt more unsustainable.
Even a restructuring of the debt – that will cause significant damage and losses to creditors in Italy and abroad – will not restore growth and competitiveness . That requires a real depreciation that cannot occur via a weaker euro given German and ECB policies. It cannot occur either through depressionary deflation or structural reforms that take too long to reduce labour costs.
So if you cannot devalue, or grow, or deflate to a real depreciation, the only option left will end up being to give up on the euro and to go back to the lira and other national currencies. Of course that will trigger a forced conversion of euro debts into new national currency debts.
The eurozone can survive with the debt restructuring and exit of a small country such as Greece or Portugal. But if Italy and/or Spain were to restructure and exit this would effectively be a break-up of the currency union. Unfortunately this slow-motion train wreck is now increasingly likely.
Only if the ECB became an unlimited lender of last resort and cut policy rates to zero, combined with a fall in the value of the euro to parity with the dollar, plus a fiscal stimulus in Germany and the eurozone core while the periphery implements austerity, could we perhaps stop the upcoming disaster.
The 1% are the very best destroyers of wealth the world has ever seen
by George Monbiot - Guardian
Our common treasury in the last 30 years has been captured by industrial psychopaths. That's why we're nearly bankrupt
If wealth was the inevitable result of hard work and enterprise, every woman in Africa would be a millionaire. The claims that the ultra-rich 1% make for themselves – that they are possessed of unique intelligence or creativity or drive – are examples of the self-attribution fallacy. This means crediting yourself with outcomes for which you weren't responsible.
Many of those who are rich today got there because they were able to capture certain jobs. This capture owes less to talent and intelligence than to a combination of the ruthless exploitation of others and accidents of birth, as such jobs are taken disproportionately by people born in certain places and into certain classes.
The findings of the psychologist Daniel Kahneman, winner of a Nobel economics prize, are devastating to the beliefs that financial high-fliers entertain about themselves. He discovered that their apparent success is a cognitive illusion. For example, he studied the results achieved by 25 wealth advisers across eight years. He found that the consistency of their performance was zero. "The results resembled what you would expect from a dice-rolling contest, not a game of skill." Those who received the biggest bonuses had simply got lucky.
Such results have been widely replicated. They show that traders and fund managers throughout Wall Street receive their massive remuneration for doing no better than would a chimpanzee flipping a coin. When Kahneman tried to point this out, they blanked him. "The illusion of skill … is deeply ingrained in their culture."
So much for the financial sector and its super-educated analysts. As for other kinds of business, you tell me. Is your boss possessed of judgment, vision and management skills superior to those of anyone else in the firm, or did he or she get there through bluff, bullshit and bullying?
In a study published by the journal Psychology, Crime and Law, Belinda Board and Katarina Fritzon tested 39 senior managers and chief executives from leading British businesses. They compared the results to the same tests on patients at Broadmoor special hospital, where people who have been convicted of serious crimes are incarcerated. On certain indicators of psychopathy, the bosses's scores either matched or exceeded those of the patients. In fact, on these criteria, they beat even the subset of patients who had been diagnosed with psychopathic personality disorders.
The psychopathic traits on which the bosses scored so highly, Board and Fritzon point out, closely resemble the characteristics that companies look for. Those who have these traits often possess great skill in flattering and manipulating powerful people. Egocentricity, a strong sense of entitlement, a readiness to exploit others and a lack of empathy and conscience are also unlikely to damage their prospects in many corporations.
In their book Snakes in Suits, Paul Babiak and Robert Hare point out that as the old corporate bureaucracies have been replaced by flexible, ever-changing structures, and as team players are deemed less valuable than competitive risk-takers, psychopathic traits are more likely to be selected and rewarded. Reading their work, it seems to me that if you have psychopathic tendencies and are born to a poor family, you're likely to go to prison. If you have psychopathic tendencies and are born to a rich family, you're likely to go to business school.
This is not to suggest that all executives are psychopaths. It is to suggest that the economy has been rewarding the wrong skills. As the bosses have shaken off the trade unions and captured both regulators and tax authorities, the distinction between the productive and rentier upper classes has broken down. Chief executives now behave like dukes, extracting from their financial estates sums out of all proportion to the work they do or the value they generate, sums that sometimes exhaust the businesses they parasitise. They are no more deserving of the share of wealth they've captured than oil sheikhs.
The rest of us are invited, by governments and by fawning interviews in the press, to subscribe to their myth of election: the belief that they are possessed of superhuman talents. The very rich are often described as wealth creators. But they have preyed on the earth's natural wealth and their workers' labour and creativity, impoverishing both people and planet. Now they have almost bankrupted us. The wealth creators of neoliberal mythology are some of the most effective wealth destroyers the world has ever seen.
What has happened over the past 30 years is the capture of the world's common treasury by a handful of people, assisted by neoliberal policies which were first imposed on rich nations by Margaret Thatcher and Ronald Reagan. I am now going to bombard you with figures. I'm sorry about that, but these numbers need to be tattooed on our minds. Between 1947 and 1979, productivity in the US rose by 119%, while the income of the bottom fifth of the population rose by 122%. But from 1979 to 2009, productivity rose by 80%, while the income of the bottom fifth fell by 4%. In roughly the same period, the income of the top 1% rose by 270%.
In the UK, the money earned by the poorest tenth fell by 12% between 1999 and 2009, while the money made by the richest 10th rose by 37%. The Gini coefficient, which measures income inequality, climbed in this country from 26 in 1979 to 40 in 2009.
In his book The Haves and the Have Nots, Branko Milanovic tries to discover who was the richest person who has ever lived. Beginning with the loaded Roman triumvir Marcus Crassus, he measures wealth according to the quantity of his compatriots' labour a rich man could buy. It appears that the richest man to have lived in the past 2,000 years is alive today. Carlos Slim could buy the labour of 440,000 average Mexicans. This makes him 14 times as rich as Crassus, nine times as rich as Carnegie and four times as rich as Rockefeller.
Until recently, we were mesmerised by the bosses' self-attribution. Their acolytes, in academia, the media, thinktanks and government, created an extensive infrastructure of junk economics and flattery to justify their seizure of other people's wealth. So immersed in this nonsense did we become that we seldom challenged its veracity.
This is now changing. On Sunday evening I witnessed a remarkable thing: a debate on the steps of St Paul's Cathedral between Stuart Fraser, chairman of the Corporation of the City of London, another official from the corporation, the turbulent priest Father William Taylor, John Christensen of the Tax Justice Network and the people of Occupy London. It had something of the flavour of the Putney debates of 1647. For the first time in decades – and all credit to the corporation officials for turning up – financial power was obliged to answer directly to the people.
It felt like history being made. The undeserving rich are now in the frame, and the rest of us want our money back.