Friday, November 25, 2011

Is Europe About to Unravel?

From The Financial Times

Rates in Italy continue to skyrocket. Today, Italy had to pay over 8% to successfully complete an auction of 2 year notes. There is a ton of refinancing due in early 2012. Do not think Italy can afford to pay 7-8% for their money. What could happen? Default, with a lot of Italian, French and Belgian banks suffering unmanageable losses on their holdings of Italian bonds.

The fix was supposed to be the European Central Bank finally stepping in and becoming a visible, credible buyer of last resort for Eurozone sovereign bonds. Analysts thought the ECB and Germany were playing sly, seeking to force out Papandreou in Greece and Berlusconi in Italy. Turns out it was more than that. These two have been replaced by unelected technocrats (Monti in Italy and Papademos in Greece), but neither the ECB nor Germany have budged on the lender of last resort issue.

Yesterday, Merkel, Sarkozy and Monti met, and Merkel reiterated her firm opposition to "printing money" in any form (either by issuing Eurobonds or by supporting existing sovereign debt to ensure yields are held down). She told the world what the "true solution" was: a much higher level of European integration with automatic and severe penalties for any country that cannot keep their economic house in order. Sarkozy, who had initially pressed for much more aggressive ECB action, relented, and supported Merkel. There's an EU meeting coming up in early December. She wants to present a roadmap to heads of state then.

Will the 17 Eurozone countries sign up for such a program, surrendering significant sovereignty in financial areas to a central bureaucracy, assumed to be under German control? I don't think so. And because all of this will require treaty changes, which mean public referendums in some countries (remember that Merkel and Sarkozy went all out to sabotage a proposed referendum recently in Greece), we are talking one to three years to get this done, even if all heads of state wanted to proceed, which I doubt will happen. So far, Merkel has said no Eurobonds, until the Master Plan is agreed to.

Merkel's Master Plan is a disaster. It's all fiscal consolidation and central (German) control, with no sense of understanding that not every country can have the same labor competitiveness as Germany, or that Germany should be thankful for the periphery countries who have been buying much of their exports, instead of beating them into the ground in the name of austerity and good discipline.

It's a bad brew. I don't think Merkel will sell this plan. And I don't think markets will wait much longer.

Markets in December will be interesting.

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