Posted on 03/09/2008 9:57:57 PM PDT by ScaniaBoy
Europe's monetary union may be tested to near breaking point as the economic downturn engulfs the bloc's southern tier, and German investors cut off a crucial source of foreign funding, according a hard-hitting report by the Swiss bank UBS.
"The coming two years are likely to prove the most testing time for the coherence of the single currency to date," said Meyrick Chapman, the bank's Europe strategist. "We expect that it will emerge unbroken. There is too much political and economic capital invested to break the project. However, adjustments are likely to be severe," he said.
UBS warned of a "funding freeze" for countries with very high current account deficits, such as Spain, Portugal, and Greece that have come to rely on in massive inflow of foreign money to plug the gap. Spain has built up the biggest cross-border liabilities with foreign debts of $362bn (£180bn), or 26pc of GDP. Italy has accumulated $275bn, Greece $129bn, Ireland $123bn, and Portugal $98bn.
Much of the funding has come from German banks and pension funds. They have shown a voracious appetite for cedillas (covered bonds) and other forms of Spanish debt at a voracious pace from 2005 to 2007. The yield was higher than stodgy offerings at home. The Germans have since brought down the guillotine.
"Following the market dislocation in July 2007, German buyers were almost entirely absent from the Spanish market," UBS said. The cut-off has left some Spanish borrowers starved of funds. Many have instead turned to the European Central Bank for temporary funding, using unsold mortgage as collateral for loans at the Frankfurt window. This is becoming a political issue. "It may raise awkward questions within the ECB Council," the bank added.
Under EU rules the funding is supposed to be "limited and temporary". Spain's banking association insists that the country's lenders are still in good health, with a solid capital base. The investor flight from the region has already become visible in the surging yield spread between German 10-year Bunds and equivalent Latin bloc bonds. After remaining steady in the mid-20s for several years, the spreads began edge up last summer and finally exploded this week. They reached 70 basis points for bonds from Italy and Greece, two countries with towering public debts over 100pc of GDP. "It is certainly a wake-up call to be cautious about fiscal policy," said ECB's president, Jean-Claude Trichet.
A number of hedge funds and banks are betting on a further divergence, taking out "short" positions on Club Med debt with an offsetting "long" contract on Bunds. Goldman Sachs, BNP Paribas, and Deutsche Bank have all advised clients over recent months to take out such positions. The "liability" countries deemed most vulnerable to such attacks vary among themselves. Spain has a current account deficit near 10pc of GDP and a collapsing housing bubble, but is in good fiscal shape. Italy's trade deficit is manageable but the country is falling into recession.
What all the southern countries have in common is a relentless loss of competitiveness against Germany, year after year for a decade.
UBS said it was unclear how Europe would deal with the likely crisis when it comes. EU rules forbid the ECB to provide liquidity to banks that are "potentially insolvent".
An IMF study said the "larger countries will end up footing a disproportionately large share of the overall burden". The Germans will not like that.
Socialists always seem to end up with a money problem....amazing how that works.
I guess since they don't like markets, markets don't like them.
They aren’t the best farmers either.
I’ve been preaching for the last 18 months that the devaluation of the dollar relative to the Euro is simple economic warfare; it has no basis in economic fundamentals; it’s just a means to break the EU.
Note that it’s a lending crisis because Germany doesn’t have enough money to lend. And why is that? Because the weak dollar/high Euro has killed Germany’s exports.
My guess is still that Germany will start to decouple from the Euro, simply because of the need for economic survival. When that starts to happen, the entire EU falls apart as an economic force, leaving the US - once again - the only 10+ Trillion dollar economic unit in the world.
btt
“Socialists always seem to end up with a money problem....amazing how that works.”
I wouldn’t gloat - our money problems are even worse!
I think EUrotopia rules also don't require the "potentially insolvent" banks to be identified, either. ECB does plenty in secret. Little transparency.
yitbos
My guess is still that Germany will start to decouple from the Euro, simply because of the need for economic survival. When that starts to happen, the entire EU falls apart as an economic force,
Does this mean too that Brussels falls apart too? Would this also kill the so called Lisbon Treaty?
If the euro (or really the Economic Monetary Union / EMU) breaks up then the EU and its treaties will go too.
I wouldn’t say they are worse but I agree, that comment was not well-thought out.
If Germany pulls out, the rest of the EU crumbles. Germany IS the EU economy - period.
Oh, and considering Belgium STILL doesn’t have a government after a year, I think Brussels is already in trouble! Don’t be surprised if in 4-5 years there is no more Belgium, but Flanders and Wallony. Belgium can’t get it together, and now that many of the Balkan states are splitting, you can bet the Belgians are watching with interest, and thinking they can split, too...
In fact, you’ll probably end up with Flanders (with it’s closer ties to the Netherlands and Germany), Wallony (closer to Luxembourg and France), and an independent city/state of Brussels (as the “seat” of the EU, it won’t want to get caught up in a split, and probably would try to become independent like Kosovo, or Singapore).
The EU can’t hold together culturally; heck, the NATIONS in the EU can’t even hold themselves together! And with the greatly devalued dollar relative to the Euro, Germany is getting its economic clock cleaned. It HAS to do something; problem is none of the other EU countries want to devalue the Euro, because that makes their deficits even bigger.
So Germany ends up with the choice of watching its own economy fall apart - and then take down the rest of the EU, or pulling out to save itself, and letting the rest of the EU sink.
My bet is that Germany will do what is best for Germany, the EU be damned.
Fundamentally, the US economy is MUCH stronger than the EU; there isn’t a rational reason for the inversion in the value of the currency.
- We have deficits, sure; the EU countries, and the EU as a whole, are running higher deficits.
- We have nothing in terms of social spending liabilities compared to the EU countries.
- We have half (or lower) the unemployment of the EU and its countries.
- We have a slightly growing population, theirs is shrinking.
- We have growing exports, they have shrinking exports.
Fundamentally, the US is financially a LOT more stable and stronger than the EU. Which is why the value change of the dollar and the Euro makes zero sense. It has to be a currency manipulation to wage a silent, cold economic war against the EU, which is the only economic force on the planet that could come close to matching the US.
You are quite right. The ECB loans to Spanish banks were revealed by our friend Ambrose E-P in late January.
ECB aid to Spanish banks matches Rock rescue:
Reliance on the ECB window appears to have kept the mortgage sector afloat despite the sharp slowdown in the Spanish property market and the de facto closure of the capital markets for this type of business, allowing Spain to avoid the sort of mishap suffered by Northern Rock in Britain and Countrywide in the US.
The data appear to confirm suspicions that the EU authorities have carried out a covert rescue of the Spanish mortgage banking system.
It may equal the taxpayer rescue of Northern Rock in Britain, and possibly exceed it in proportion to the overall size of Spain's economy.
The key difference is that the ECB rescue operation in Spain has been disguised. A veiled method is necessary since the eurozone lacks a clear-cut lender of last resort. The IMF has warned that this gap in the architecture of of the single currency could prove serious in a crisis.
Oh, interesting thread just posted:
http://www.freerepublic.com/focus/f-news/1983122/posts
Sure enough, Germany is already getting hammered. BMW is laying people off in Germany, and hiring over here in the US. For a country like Germany that has always been an export-based economy and the economic engine of Europe, this has to really sting!
Note that at the moment it is France, Italy, Spain et al who wants the euro rate down. The Germans want to keep the euro strong. Perverse, maybe, but that’s politics for you.
I t can be explained in economic terms, though. Especially Italy, but many other European countries as well, have dropped in competitive strength vis-à-vis the Germans during the last decade.
This is where the great fault line in the euro lies. The Germans have not understood it yet, but once the Lisbon treaty has been signed and sealed the European Central Bank is no longer independent, and I foresee an almighty political fight over the interest rates and the foreign exchange rate. France will do its utmost to take hold over the bank and force a de facto devaluation of the euro.
Aaaah, yes. The euro. Stealth capitalism.
The bankers knew that, if the experiment were to work, EUrotopia must prove it with a common currency. They insisted, otherwise they would not back the EU. If EU were to fail, deviation from free enterprise capitalism would be the reason.
This fact was first propounded at FR by MadIvan well before the turn of the century.
yitbos
Ahh, I miss him. (Although, I have to say that I don't fully agree with him on this one. The euro was in no small part a political project conceived and brought about against the will of many bankers.)
Sure, the state controled banks. Recall the Saxony bank, half owned by the state, had to be bailed out by taxpayers.
The international guys, the big boys, wanted a common currency.
Sarkozy wants a central Eurobank controlled by Brussels (politics). You are correct, Lisbon, sooner or later, does just that. When that happens, capital will leave EUrotopia as if it were a bad Latin American country.
Time to take a profit on the euro and bring it home to Uncle Sam.
yitbos
“Fundamentally, the US economy is MUCH stronger than the EU; there isn’t a rational reason for the inversion in the value of the currency.
- We have deficits, sure; the EU countries, and the EU as a whole, are running higher deficits.
- We have nothing in terms of social spending liabilities compared to the EU countries.
- We have half (or lower) the unemployment of the EU and its countries.
- We have a slightly growing population, theirs is shrinking.
- We have growing exports, they have shrinking exports.
Fundamentally, the US is financially a LOT more stable and stronger than the EU. Which is why the value change of the dollar and the Euro makes zero sense. It has to be a currency manipulation to wage a silent, cold economic war against the EU, which is the only economic force on the planet that could come close to matching the US.”
I agree with all that and I’m just as stumped as you are as to why the dollar is so weak vs the Euro, and I don’t think there is any conspiracy manipulating the market. I wonder if there’s anyone else better informed out there that can help explain this seeming paradox!
I’m leaning heavily toward betting that the dollar will start getting stronger vs the Euro (by actually investing some money), but it would be nice to have an explanation of the fundamentals that would shed some light on this “mystery”.
egggscellent!
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