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"...If calling the macroeconomic cycle is a very challenging task, then what about politics? However, this is exactly what investors are forced to look at presently and their natural reluctance to engage in such an exercise is plainly visible in the fear permeating financial markets. To complicate matters further, many countries have fairly fragile executive powers in place to tackle the daunting task of de-gearing Western societies."
(...)
Nevertheless, these situations cannot compare with the state of affairs in the Eurozone and nothing encapsulates this better than Christine Lagarde's turncoat. On July 23rd, acting then a France's finance minister, she congratulated herself (sic) for the good results of French banks at the latest stress tests. On August 27th, acting now as IMF president, she called for "substantial" and mandatory recapitalisation to bolster European banks' balance sheets without excluding those same French banks. The risk of implosion of the Eurozone before year end is real.
There can be only two solutions, diametrically opposed: A) mutualisation of the sovereign risks ("the Eurobond solution" which is in effect nothing less than the creation of the United States of Europe); or B) dismantling of the monetary union. The consensus view is that scenario A will prevail, probably because it would be easier to implement initially (however the long term political consequences would be extraordinarily difficult to manage which is exactly the reverse of scenario B) and also because the idea of having the Germans pay for everybody else is very attractive to all the other European citizens.
Personally, I stray from consensus on this as I am not convinced that scenario A is a much more likely outcome than scenario B. It is clear that it will be the German government which will decide for everybody else when it comes to the final decision on the Eurozone. They have seen Greece continuing to take the other members of the monetary union for a ride. Unbelievably, no asset has been sold yet by the Greek government* and public spending to date this year, excluding the servicing of the debt, is up 4.6% (yes it is a plus sign in front of this number).
They have seen Berlusconi drumming up no less than three different austerity plans this summer to finally decide, after the ECB's purchase of Italian debt had artificially relieved the pressure on yields, that the danger was not imminent and that the austerity plan could be safely watered down to a meaningless train of small scale measures. Germany is under no illusion on the reliability of her partners in that monetary union from hell. If the risk of losing access to financing cannot force members of the "club Med" to toe the fiscal line, how would they behave if they had the safety net of Eurobonds (and the implicit guarantee that members from the north would foot the bill)?
I think that the German government is acutely aware of the risk of getting embroiled in a mechanism which would make them the lender of last resort for the Eurozone and that they have no confidence whatsoever on their partners (justifiably so one could add). Their plan is to continue on insisting for stringent fiscal austerity as the only cure, knowing full well that it cannot work for Greece and that it is a death trap for Italy, Portugal and Spain**, making life unpalatable to these same countries so that ultimately these would want out. The coming months are going to be rich in crises and dramas. I do not want to be a seller of volatility in this context. "
** "If Italy had to pay the market rate on her debt (6% before the ECB's intervention) and were to bring back her debt to 60% of GDP in let's say 20 years, it would represent in the first years an effort equivalent to 10% of GDP. The same effort would represent c 2.5% for Germany. Staying in the Eurozone would be a guaranteed slow death for the Italian economy."
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