Plan Number . . . I’ve Lost Count

Equity markets around the world are spiking on news of Le Plan du Jour/Der Plan des Tages being floated by the French and the Germans.

Basically, it is just a variant on an old theme: fiscal integration, but with teeth this time:

Angela Merkel and Nicolas Sarkozy . . . are said to be putting together a framework for a rapid move toward greater fiscal integration. Such a plan would likely entail oversight of member-state budgets—and a corresponding loss of sovereignty—with the understanding that such ties would facilitate the way toward sovereign risk-sharing, as through euro bonds. The prospect of fiscal submission to the will of the euro zone’s big powers is unlikely to appeal to peripheral countries, but many have already accepted some degree of oversight in exchange for emergency assistance, and the alternatives are likely to be far worse. To get around the need to go through a lengthy and uncertain treaty-change procedure, the plan may be drawn up along the lines of the Schengen agreement on geographic mobility. Countries may be able to sign on on a voluntary basis; it will not be an all or nothing approach. Given the scale of the current debt crisis, mutualisation of fiscal responsibilities won’t fix the mess. The main hope for the plan is clearly that a major step toward better fiscal institutions will encourage the European Central Bank to substantially step up its intervention in bond markets.

But the teeth are the problem.  Or, put differently, the lack of panzers is the problem.

The Economist piece is right to recognize that “mutualisation”–i.e., having Uncle Fritz pick up the tab–won’t work.  It won’t work because Fritz (or, more accurately, German taxpayers) aren’t willing to do it, and even if they were, it is doubtful that even Germany has the financial wherewithal.

But if Germans aren’t willing to tax themselves more to pay for what they perceive to be Greek, Italian, Portuguese, and Spanish profligacy, why should anyone expect that Greeks, Italians, Portuguese, and Spaniards are willing to tax themselves much more to pay for what they perceive to be German miserliness?  Which leads to a focus on one of the italicized sentences: any voluntary agreement requires Greek, etc., consent.  How likely is that?  And even if they consent now, are their promises credible?  Will southern Europeans agree to be bitten, and will they stand still to be bitten?  Can Germany et al really bite?  Color me extremely skeptical on each count.

Although the plans themselves have huge holes, as the rapid sequence of announcement and fading away demonstrates, the announcements and leaks (e.g., the completely unsourced story in an Italian paper that the IMF was going to finance Italy) serve a purpose.  The rumor mill will keep on grinding as long as the rumors have even a temporary market impact.  This buys time, which suits the natural proclivity of politicians to procrastinate, but which also does make some miraculous outcome possible.  Time to pressure the ECB into becoming the lender of last resort–or, more aptly, debt monetizer of last resort (because although a liquidity crisis is the current symptom of the problem, it’s much more than that); or time to pressure the Fed into becoming the European lender of last resort.

Which means that today’s market bounce will produce a bounty of new rumors and plans.

Just in time for Christmas.

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About Craig Pirrong 238 Articles

Affiliation: University of Houston

Dr Pirrong is Professor of Finance, and Energy Markets Director for the Global Energy Management Institute at the Bauer College of Business of the University of Houston. He was previously Watson Family Professor of Commodity and Financial Risk Management at Oklahoma State University, and a faculty member at the University of Michigan, the University of Chicago, and Washington University.

Professor Pirrong's research focuses on the organization of financial exchanges, derivatives clearing, competition between exchanges, commodity markets, derivatives market manipulation, the relation between market fundamentals and commodity price dynamics, and the implications of this relation for the pricing of commodity derivatives. He has published 30 articles in professional publications, is the author of three books, and has consulted widely, primarily on commodity and market manipulation-related issues.

He holds a Ph.D. in business economics from the University of Chicago.

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