Spanish Bonds in Andalusia

The Bulava-esque trajectory of the “bailout” of the Spanish banks would be hilarious if it weren’t so tragic.  But it was predictably tragic.

The Euros pulled one of their characteristic delay and pray moves.  (Though, being thoroughly pomo, I doubt praying had much to do with it.)  In essence, they funded-maybe, because the details of the funding and the identify of the funder(s) are Players to Be Named Later-the movement of Spanish bank liabilities onto the balance sheet of the Spanish government.  This boosted the debt-to-GDP ratio of Spain to the severe pain range: uhm, bringing the SPVs on balance sheet doesn’t make the entity stronger; quite the contrary.  A level that is likely unsustainable given the dire economic straits the country finds itself in, with GDP contracting and unemployment at Great Depression heights.  Moreover, the move has affected the game between the EU and the other debtor nations, who see that Spain extracted a deal that compares favorably, in terms of “conditions” to theirs.  Thus, Ireland may want a renegotiation of its deal, and the Greeks may conclude that telling the Troika to eff off might be the best course.  Moreover, it gave those holding bonds not just in Spain but in other precarious countries-notably Italy-serious concerns that they might be subordinated.

Furthermore, by absorbing a big chunk of EFSF/ESM resources, the Spanish bailout raised serious questions about their ability to assist other countries, with Italy again at the top of the list.  This further increases the angst of bondholders. (A warning to CCPs that have resources to absorb the default of N members, but no means to recapitalize.  When the N-2d or N-1st default occurs, there is likely to be a run on the CCP, making its ultimate demise almost inevitable.)

Hence, after an initial burst of foolish EUphoria, Spanish bond yields spiked, as did those on Italian debt.

Well played!  Well played! Bravo!

No, Europe’s real choices, as opposed to its finger-in-the-dike stopgaps, are exactly the same as they were last year, and the year before that.  Amputation or gangrene.  Socialization of debt or dissolution of the Eurozone as it currently exists.

But Europe refuses to grasp those nettles.  Truth be told, moreover, it seems impossible that they can negotiate the arrangement necessary to make socialization palatable to those who are likely to be net contributors-notably, the Germans. Germany obviously does not want to be Europe’s ATM, and reasonably demands mechanisms that limit its exposure.  Furthermore, it is highly unlikely that the electorates of other nations are willing to surrender sovereignty, or undertake the structural reforms* necessary to make them competitive and put them on a reasonable growth trajectory.

Indeed, look at the delusional policies that France is pursuing.  Lowering the retirement age.  Looking to make it virtually impossible to layoff or fire anybody-which will mean that it it will be financially insane to hire anybody in the first place.  In the name of growth!  These policies are popular-not only did Hollande win, but the Socialists won an outright majority in the just-finished parliamentary elections.

Good luck with that!  Be careful what you ask for!

Everyone is importuning Merkel and Germany to save them.  Particularly annoying are the gratuitous proddings of Timmy! and Obama.  Timmy!’s post-bailout-that-wasn’t-a-bailout remarks were particularly grating.  Sayeth Timmy!: the bailout represents”concrete steps on the path to financial union, which is vital to the resilience of the euro area.”

Read that again.  Geithner, whom the (relatively) solvent Euros loath, is telling Europe that financial union is the way to go.  What chutzpah.

Germany realizes that such a financial marriage in haste will permit it plenty of time to repent its error at its leisure.  But there isn’t time to negotiate a solid pre-nup before the whole thing goes up the spout.  And I doubt there is a pre-nup that all parties are willing to sign, or would adhere to if they did.

The core of this game is empty, it seems to me. Which means that it is a matter of time before the whole thing collapses.  And that time is drawing nigh.

* Structural reform-supply-side measures, if you will-are essential to supporting long run growth.  But commentators insist on either misunderstanding this, or grossly mischaracterizing it.

For instance, consider the recent Roubini-Ferguson oped on Europe:

Structural reforms that boost productivity growth should be accelerated. And economic growth needs to be jump-started. The policies to achieve this include further monetary easing by the ECB, a weaker euro, some fiscal stimulus in the core, more bottleneck-reducing and supply-stimulating infrastructure spending in the periphery (preferably with some kind of “golden rule” for public investment), and wage increases above productivity in the core to boost income and consumption.

Uhm, none of those are structural measures.  They are all variants on Keynesian nostrums.

But that is nothing compared to the truly aggravating Martin Wolf:

Moreover, “structural reform” is a woolly term. If by this Mr Schuknecht means that falling prices, induced by ultra-high unemployment, debt deflation and sovereign and banking insolvencies, will ultimately restore competitiveness, he is correct, provided the country is able to stick with such policies, for a very long period indeed (probably a decade, or even far longer). This is what is required if a country with a large private sector debt overhang and a sizable structural current account deficit is to eliminate its fiscal deficit, regain competitiveness and restore growth, particularly in a currency union whose core country has a structural current account surplus and low inflation. The question is whether democratic politics (or the eurozone) will survive the experience. I doubt it.

Way to bash a straw man there, Marty! You know that’s not what German FinMin official Ludger Schuknecht meant by the term, and for you to insinuate otherwise is truly low.  Schuknecht is referring to the kinds of labor market and other reforms that transformed Germany from the sick man of Europe to the prosperous nation whose pocket everyone wants to tap.  If you want to discuss structural measures, at least do it fairly.  John Stuart Mill you ain’t. (Mill was/is legendary for his even-handed characterizations of his opponents’ views.)

With these clueless or deeply misleading analyses from esteemed purveyors of opinion, structural reforms don’t stand a chance.  Especially in delusional countries like France, which are hell-bent on implementing structural deforms.

After all that, isn’t a little musical entertainment in order? I think it is!

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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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