January 8, 2011
by Irwin Stelzer
The Christmas truce is over and the battle between the financial markets and the euro-zone managers resumes.
If understanding your enemy is essential to victory, the euro zone starts at a disadvantage.
The disparate group that makes up the euro-zone general staff just doesn't understand how markets work.
So when German Chancellor Angela Merkel and French President Nicolas Sarkozy announced that, starting with the 2013 campaign, they would inflict losses on investors, they were surprised that the counter-attack took the form of a sell-off of bonds and a rise in interest rates.
Now the battle recommences -- between enemies who fail to realise that they need each other. The euro-zone army needs the market to provide capital, and the markets need the euro-zone generals to provide certainty and stability so that they can invest in relative safety.
Investors are about to be called on by euro-zone borrowers to cough up record amounts of capital.
European governments have to roll over about E555 billion ($726bn) in debt in this new year, with euro-zone countries expected to borrow some E80bn this month alone.
The euro-zone bailout facility will be in the market for another E13bn to fund its Irish adventure. All in all, forecasts Royal Band of Scotland, European governments' gross debt issuance this year will come to E814bn, 10 per cent of it in January alone.
This is in addition to about E400bn that European banks are expected to need in the first half of this year. Break that down and the vulnerability of the euro zone becomes even clearer.
Portugal, which found a cut in its credit rating in its Christmas stocking, needs E20bn and seems likely, despite the denials of Minister of the Presidency Pedro Silva Pereira, to tap the euro-zone bailout fund, even if China does take up E5bn in bonds and Brazil picks up a billion or so more.
The euro-zone bailout fund can easily handle a sum of that size. But Spain will need about E80bn, and that's real money.
The problem is exacerbated by leap-frogging. Every borrower wants to beat other borrowers to the market.
That should make January and, indeed, the entire first quarter of this year very difficult for all borrowers, and drive up borrowing costs even for sounder borrowers such as Germany and France, which between them will be issuing E380bn in bonds this year.
Indeed, next week will tell us a lot.
It should witness several auctions of government bonds at which investors will provide an indication of the interest rates they are likely to demand for the rest of this year.
As they rang out the old year, euro-zone policymakers agreed on one thing: they had communicated poorly with the markets last year. There is some truth in that self-analysis, but only some. The fact is, they perfectly communicated their inability to agree on a policy for coping with the problem initiated by Greece's inability to fund its ongoing deficits.
Some prescribe austerity, while others argue that such austerity will only produce a downward spiral of recession and eventual default. Some want the European Central Bank to buy more of the sovereign bonds that the market will absorb only at ruinously high interest rates, others want the bank to remain independent of the political problems of euro-zone members and concentrate on controlling inflation.
Some want private investors to visit the barber before the euro zone tidies up the finances of unkempt members, others say the threat of such haircuts will only make the ultimate bailout more costly. Some speak of sovereign defaults, but only in a whisper.
Given the sad state of economic theory as a guide to practical policy, these differences are understandable. But two areas of agreement have emerged from the squabbling.
The first is that there is no solution to the euro-zone crisis that does not include policies for stimulating growth in the periphery to match the rates in Germany and France.
Portugal and Spain cannot avoid default or bailouts if they don't rack up significant economic growth. Just imagine the terms on which they would be able to borrow if their economies were growing at an annual rate of, say, 4 per cent.
The good news is that there is renewed interest in peeling back the labour market restrictions, the barriers to new entrepreneurial ventures, the webs of regulations that stifle growth. The bad news is that such renewed interest is crashing against Brussels' inclination to tax and regulate.
The cost of running the EU has gone up; the European Parliament is calling for a eurotax; new regulations that seem set to hobble the financial sector, misunderstood and loathed by market-haters in Europe, are being implemented. In short, there is an absence of what Tony Blair called "joined-up government" -- a linkage of all policies to the one overwhelming need, in this case economic growth. But at least there are now voices calling for just such linkage.
The second area of agreement is that it is no longer possible to combine uniform monetary policy with 16 -- 17, now that Estonia has signed on -- separate fiscal policies.
Some form of fiscal union is required if the euro is to be saved from the dustbin of history.
Agreeing on the form of that closer union is the most urgent task facing the various players in the multi-dimensional game of euro-politics.
A series of difficult auctions next week, with interest rates climbing, might just speed agreement, giving investors some of the certainty they crave and euro-zone governments the cash they need.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.
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