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RBA takes fright at a desperate 
eurozone

No wonder the Reserve Bank cut interest rates yesterday. Central banks and governments around the world are increasingly concerned about the debacle in Europe. With Friday’s critical summit meeting approaching and the policy options looking decidedly limited, the RBA’s timing is impeccable, even with the confirmation of how robust the local economy is via the GDP figures. But let’s hope the pre-emptive cut will prove to be a bonus, and not the first of a few as Europe slowly implodes over the Christmas New Year period.

On current form that looks overly optimistic. When the RBA cut rates in November, the bank was more confident Europe was moving to tackle the crisis. “Financial markets have recovered somewhat from the turmoil of recent months, helped by stronger economic data in the United States and by signs that European governments are making progress in their efforts to deal with the sovereign debt and banking problems,” Glenn Stevens said in the November 1 meeting statement. But yesterday was a completely different story:

The sovereign credit and banking problems in Europe, to which European governments are still seeking to craft a full response, are likely to weigh on economic activity there over the period ahead. Financial markets have experienced considerable turbulence, and financing conditions have become much more difficult, especially in Europe. This, together with precautionary behaviour by firms and households, means that the likelihood of a further material slowing in global growth has increased. Commodity prices have reflected this, declining further over recent months and taking pressure off CPI inflation rates. This has increased the scope for some easing in monetary policy in a number of countries.”

And, in the most significant change of all, the bank has moved monetary policy from November’s “neutral stance” to one in which “the Board will continue to set policy as needed to foster sustainable growth and low inflation over time”. In other words, rates will be cut if Europe continues to worsen (and Friday night’s summit fails) and they will be held at low levels until the situation stabilises, much like in 2008-09, when they will be returned to normal levels.

The Europeans are ostensibly concentrating on two issues. One is longer-term reform of the eurozone, or the EU if they can herd recalcitrants like the British along, to reduce the policy disparity between monetary union and fiscal regionalism that is one of the core problems of the Euro. The other is the decidedly more urgent task of saving the Euro. The former is about establishing a framework to prevent a repeat of the crisis. The latter is about preventing immediate catastrophe.

The problem is, no one has any confidence Europe’s leaders can avert catastrophe. The Asian edition of the Financial Times this morning reported on negotiations over “a much bigger financial ‘bazooka’ … that could include running two separate rescue funds and winning increased support for the International Monetary Fund. According to senior European officials, negotiators are considering allowing the eurozone’s existing €440 billion bail-out fund to continue running when a new €500 billion facility comes into force in mid-2012, almost doubling the firepower of the bloc’s financial rescue system.”

This is about as close to a clear admission of failure as we’ll be getting from European leaders. The €440 billion euro stability fund was devised in May last year and has since been used to provide rescue loans to Ireland, Greece and Portugal, with €220- €240 billion committed so far. As part of the last big deal to “resolve” the crisis, European leaders agreed weeks ago to try to find ways of boosting the fund by raising more money from other countries, such as China and Japan, or doing a deal so that the European central Bank and the IMF become involved.

All that has failed to happen but rather than admit defeat, European bureaucrats are now looking at a European Stabilisation Mechanism (ESM) which could be funded by up to €500 billion of cash from member states. The ESM was supposed to replace the EFSF (confused already?) in 2013, but the new ploy is to keep the existing fund going and to boost the total amount available to defend the eurozone to 900 billion euros, less the amounts committed to the bailouts of Greece, Ireland and Portugal. To further boost its attractions there’s talk of doing a deal with the ECB, but seeing the Germans refused to consider a funding deal for the existing fund, why would they agree to the central bank funding the ESM?

The ESM hasn’t been approved by member countries (and remember the existing fund saw governments in Slovakia and Finland collapse over the issue before approval was given, and the Dutch Government come under enormous internal pressure) and that will be another sticking point. Who will contribute to the additional fund is unclear: Greece, Ireland and Portugal will hardly be expected to put cash into the new fund (it would never be approved anyway) and Spain and Italy, as two potential beneficiaries, don’t have the cash to do so either and their governments are focused on inflicting more pain on their citizens to avoid bailout.

None of this is likely to get the ogres at Standard & Poor’s onside. Why S&P? Well, a day after delivering their historic warning to the eurozone, including the six AAA rated countries led by Germany, of a mass downgrading of credit ratings, S&P yesterday took aim at the rating of the EFSF, placing it on “negative” watch.

Depending on the outcome of our review of the ratings on EFSF member governments, we could lower the long-term rating on the EFSF by one or two notches, if any,” said S&P. A “CreditWatch negative” placement means there is at least a one-in-two probability that the rating will be lowered in the short term, it warned. With a AAA rating, the EFSF is able to raise funds in the bond market with much lower interest rates than bailed out nations would get on their own. If it’s downgraded, the cost of raising funds increases.

Then again, the EFSF isn’t, by the ready admission of European leaders, going to be sufficient anyway. Europe is out of money, out of ideas and, soon, out of time. Barring a miracle on Friday, we’ll be seeing more rate cuts from Martin Place early next year.

11
  • 1
    Posted Wednesday, 7 December 2011 at 1:49 pm | Permalink

    This is a very sad development for the Euro and the EU.

  • 2
    Peter Bayley
    Posted Wednesday, 7 December 2011 at 2:01 pm | Permalink

    The moves by France and Germany are predictable and will do no good. The problems that led to this state of affairs (removal of controls in an arms-race to be top financial dog, leveraging of 26-to-1, etc) cannot be solved by more, higher-interest debt. Austerity won’t work either as it crushes earnings and therefore repayments. The solution is to go Iceland’s way and forget the debts as they were essentially illusory (only by assuming 0% risk are you likely to receive 100% back - unless you persuade a naive government to take over Bank debts at 100%. For a REAL understanding of the European situation, see http://t.co/LcC5lYdZ

  • 3
    Peter Bayley
    Posted Wednesday, 7 December 2011 at 2:08 pm | Permalink

    Another, more-entertaining but just as accurate analysis is the phenomenon that is Max Keiser and Stacy Herbert. More at http://bit.ly/ure2Gf

  • 4
    Jenny Haines
    Posted Wednesday, 7 December 2011 at 2:27 pm | Permalink

    I am no banker, financier or economist, but it seems to me that there is only so many times you can shift the debt around and refinance using printed money before that strategies runs out of value. The middle and working classes of Europe, and the US are about to pay for the greed and selfishness of the financiers. No wonder the Italian Social Welfare Minister was crying yesterday. She must see what is coming and it aint pretty. The question now is how much of the house of cards Europe is going to pull down with it?

  • 5
    C@tmomma
    Posted Wednesday, 7 December 2011 at 2:50 pm | Permalink

    I can’t understand why the failed banking houses who brought all this down on our heads can’t be made to pay? Can’t governments find the guts needed to reregulate the Financial Sector for the good of the world? Why do the poorest citizens of the world have to pay? Why can’t governments find a way to make tax-avoiding and evading companies pay their reasonable dues? That’s where all the money has gone to fund a solution to this crisis, to the tax havens of the world. What happened to the mooted action to outlaw the tax haven’s dirty work for the wealthiest 1% and corporations? I don’t care if they get upset if someone in a courageous government takes away their lolly, what are they going to do? Leave the world?

  • 6
    Peter Bayley
    Posted Wednesday, 7 December 2011 at 3:18 pm | Permalink

    @C@TMOMMA The Banking houses are untouchable because they have successfully lobbyed the US Government to dismantle all the checks and balances laws put in place after the Depression - and have then filled top Government financial jobs with their own people. So, of course, THEIR government does THEIR bidding and keeps them safe. BTW the same thing is happening in Europe - the so-called “technocracts” in Greece and Italy are really Bankers ( and shouldn’t be called Prime Ministers as they are not even ministers)

  • 7
    Microseris
    Posted Wednesday, 7 December 2011 at 3:50 pm | Permalink

    Like Jenny I am no economist, but I can reasonably conclude an economic system which is predicated on speculation and perpetual growth is doomed.

    The only question is when.

  • 8
    Mack the Knife
    Posted Wednesday, 7 December 2011 at 4:47 pm | Permalink

    The dead cat seems to be bouncing less high with each new plan. Perhaps its time for the world to accept that the too big to fail institutions need to go under without rescue packages to the banks who patently are just abusing them with business as usual attitudes.

    Only then when these callous and greedy mega CEOs fall can we all rebuild and hopefully never give these banks this power again. And bring in laws to not only gaol them but strip their assets as proceeds of crime when they transgress.

    The most disgusting thing I’ve seen was Greenspan, pretty much one of the deliberate architects of the GFC, joining Paulson a major hedge betting profiteer from the misery of the GFC as his payoff.

  • 9
    AR
    Posted Wednesday, 7 December 2011 at 8:29 pm | Permalink

    If anyone is interested in a preview of what we in OZ will be hearing, should China stop buying our shovellings, they’d be well advised to read the recent national address by Ireland’s PM, Enda Kenny -
    http://www.broadsheet.ie/2011/12/04/enda-you-are-not-responsible/
    A more blatant example of “their fault, you’re gonna pay, and your kids, if any..” would be hard to find in english.

  • 10
    Ian
    Posted Thursday, 8 December 2011 at 2:32 pm | Permalink

    @Peter Bayley,

    Your analysis covers the situation quite well. It seems to me the only people who don’t recognize or won’t own up to the fact that the system is broken and there is no fix for it are the establishment economists (ex bankers in the main) and politicians who call the shots.

    The American “solution” of printing more and more money and lowering already low interest rates to practically zero - the very policy that lead to unsustainable debt, the housing bubble and speculative games by bankers which brought about the crisis in the first place - is patently not the answer; its the cause stupid!

    The European solution of austerity measures followed by more austerity measures that stifle growth, reduce government revenues and inflame citizen/victims leaving countries in a worse positions than to begin with is another pretend solution.

    In the process of all of this what democracy remained in the US and Europe took a beating with a referendum thwarted and, in Italy, an earlier referendum against privatizing its water supply (I think) likely to be ignored.

    Debt that can’t be repaid wont be repaid, that’s the nub and the can they are kicking down the road will rebound with venom as the piece of elastic tied to it is stretched to its max.

    Greece should have followed the Iceland example right in the beginning as now its only option is perhaps to auction off the entire country - minus its ports and beaches which have already been sold. Perhaps China may be interested as a way to rid itself of all those precarious US & European bond it holds?

  • 11
    Observation
    Posted Thursday, 8 December 2011 at 2:36 pm | Permalink

    The financial institutions are too big! Bigger and more powerful than any government. They just have to play out this fanciful illusion that all is being done to protect the people and each countries sovereignty to get the economy back on an even keel. The tax payers have to pay for this…which weakens governments even more while the banks remain fat with cash.

    I think the general public subconsciously knows they are being duped. But with a powerful media propaganda machine the money powers keep the revolutionaries at bay.

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