The €750 Billion Package That Will NOT Rescue the Single Currency

Monday, May 10, 2010

A world wide web full with news on the €750 billion (roughly €2,500 per Eurozone inhabitant) rescue package for the Euro hammered out in a 14-hour meeting of EU finance ministers and agreed upon when Tokyo markets opened has failed to answer the most basic question: Where does the money come from except the taxpayers pockets?
These are the 2 key points of the EU package (pdf):

  • The EU Commission will fund a €60 billion programme whose payouts will be attached to stringent terms like that of the International Monetary Fund (IMF).
  • The Eurozone will guarantee another €440 billion in bailout money over the next 3 years on a pro-rata basis of the Eurozone members. 

There was no word from where this money will come from save for piling up more debts in the Eurozone.
This was last tried in the US property bubble. We all know the outcome.
The IMF will contribute at least €250 billion to rescue the Euro, according to media reports which have not yet been confirmed by an IMF release. So far the IMF only announced a €30 billion stand-by arrangement for Greece.

Opening the Floodgates for Debt-Monetization
The true diabolic move that will undermine Eurozone government bonds comes from the ECB which will begin to monetize Eurozone government debt by buying bonds in the secondary market and 3 other measures including a reopening of swap lines with other central banks that can only be called quantitative easing by supplying 1,100 troubled Eurozone banks with all the liquidity they want.
This will be fun for hedge funds and other speculators who recognize the Euro's problems are far from over despite these "whatever it needs" measures that will undermine and not underline Eurozone bonds. Speculators can now drive up bond yields and then go long with the comfortable perspective that the ECB will intervene at some point, virtually guaranteeing profits. This system brought down the British pound under the equally ill-fated design of the European Monetary Union in the 1990s.
Here are the ECB's measures in detail that will flood banks with liquidity as soon as Tuesday:
  1. To conduct interventions in the euro area public and private debt securities markets (Securities Markets Programme) to ensure depth and liquidity in those market segments which are dysfunctional. The objective of this programme is to address the malfunctioning of securities markets and restore an appropriate monetary policy transmission mechanism. The scope of the interventions will be determined by the Governing Council. In making this decision we have taken note of the statement of the euro area governments that they “will take all measures needed to meet [their] fiscal targets this year and the years ahead in line with excessive deficit procedures” and of the precise additional commitments taken by some euro area governments to accelerate fiscal consolidation and ensure the sustainability of their public finances. In order to sterilise the impact of the above interventions, specific operations will be conducted to re-absorb the liquidity injected through the Securities Markets Programme. This will ensure that the monetary policy stance will not be affected.
  2. To adopt a fixed-rate tender procedure with full allotment in the regular 3-month longer-term refinancing operations (LTROs) to be allotted on 26 May and on 30 June 2010.
  3. To conduct a 6-month LTRO with full allotment on 12 May 2010, at a rate which will be fixed at the average minimum bid rate of the main refinancing operations (MROs) over the life of this operation.
  4. To reactivate, in coordination with other central banks, the temporary liquidity swap lines with the Federal Reserve, and resume US dollar liquidity-providing operations at terms of 7 and 84 days. These operations will take the form of repurchase operations against ECB-eligible collateral and will be carried out as fixed rate tenders with full allotment. The first operation will be carried out on 11 May 2010.
Liquidity Band-Aid for a Solvency Wound
Criticism on the package agreed by EU finance ministers abounded as soon as these measures were released. Barcelona-based economist Edward Hugh said in an email,
"a liquidity band aid (even if a large one) on what is essentially a solvency wound. It is only a matter of time before the blood starts seeping out again."
What is entirely missing are structural reforms regarding both public finances and capital markets regulations. The EU has not advanced one step as the UK opposes all measures to rein London city banks and long-term estimates by the ECB see public debts rising for at least another 4 years.
European stock markets reacted with a knee-jerk move to the upside especially in the bank sector and a rally in the Euro to the $1.30 mark. Gold eased back below the $1,200 mark but steadied at $1,190 per troy ounce.
CDS spreads eased significantly Monday morning, Bloomberg reported:
The Markit iTraxx Europe Index of credit-default swaps on 125 companies with investment-grade ratings tumbled 33.5 basis points to 99.5, with banks leading the biggest one-day decline, according to Markit Group Ltd. Swaps on Greece fell 258.5 basis points to 657, Portugal dropped 162 to 263 and Spain declined 81.5 to 157, according to CMA DataVision. Contracts on France, Germany and the U.K. also fell.
I assume it is fairly safe to say that the single weapon of creating more fiat money in order to pile up more debts in the end will not help the Euro but is probably just another nail hammered into its coffin.
Structural problems have not been addressed while the EU suddenly focuses on defending the Euro. Common sense implies that a weaker Euro is not all that bad for exporters and when looking at budget deficits in the core currency countries the fear of a fallout in Europe is exaggerated when compared to other key economic areas.
Budget deficits as a percentage of GDP:

  1. Eurozone 6,3%
  2. Japan 9%
  3. US  10%
  4. UK 12.3%

As all these figures are far from ideal - the Euro convergence criteria stipulate a maximum of 3% - and unsustainable in the near and far future we can expect to see a hunt for yield in bond markets later this year as current yields in all four currencies do not at all reflect the fiscal risks that will remain for time to come.
I also have yet to come across a sound argument for buying bonds from the more stable Eurozone countries when their interest rate advantage is distorted by the fact that stronger economies will lend to Greece at 5% while Greek yields have been slipping into 2-digit territory.
It will not only be interesting to follow the coming bloating of the ECB balance sheet to probably new record levels but it may also be profitable to enter new shorts, said Jonathan Tepper of Variantperception.com:
This is hilarious stuff. They are piling more debt onto debt. And the indebted countries themselves are contributing to their own rescue. 
France and Germany wanted a weaker Euro to help exports. They got it, but now they don't like it. 
You can't make this stuff up.
For all those who took off shorts and sold out their puts late last week, this is beautiful. You can now put on old positions at much better levels.
I concur.

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