You have to feel for the politicians and central bankers a bit: they need to deal with what is plainly an emergency, while appearing nonchalant, so as not to scare everyone and make it worse.

For example, the G7 finance ministers held a much-anticipated meeting about Europe last night, while saying it was just an ordinary conference call. Nothing was announced. A spokesman for the EU Economic and Monetary Affairs commissioner, Olli Rehn said later that it was “just part of the regular exchanges”. No big deal; move along please.

Spain’s Prime Minister, Mariano Rajoy, is refusing to make a direct plea for help from Europe’s bailout funds because he fears spooking the markets even more than they are already, leading to a politically damaging formal rescue, even though it is plain to all that Spain needs rescuing so it can rescue its banks.

The Australian Reserve Bank cut interest rates by 0.25% yesterday, mentioning the problems in Europe, but concluding soothingly that the rate cut was happening because the outlook for inflation “afforded scope” for it.

Economists had earlier predicted a 0.25% cut because to do 0.5% would have seemed panicky, so best not.

The Treasurer Wayne Swan then tried to spin it as being a good thing, as if the RBA only cuts interest rates when the economy is going nicely. Yes, it is good for borrowers that the cash rate is 3.5%, but not so good for savers, and definitely not good that a rate cut is needed.

Plain speaking is at a premium at the moment because political polls have a habit of following stock markets up and down, and more substantially, a 10% decline in the equity market has been found to trim GDP by 0.5-1% because of the wealth effect.

The plain truth is that while the global financial system had a conniption in 2008 because of the bursting of the bubble in US housing, subprime mortgages and fancy derivatives based on them, a bigger goose was in the oven, cooking, and is now cooked.

That particular fowl is the fact that European Monetary Union doesn’t work. It’s not even a bubble really, except perhaps in the false dreams of unity. The single currency did nothing more than provide the illusion of homogeneity where none exists and could never exist, but unfortunately the banks were sucked in by it and lent as if all euro borrowers were equal.

They are not, and as with the American banks in 2007-08, they suddenly have insufficient capital.

And now the world is on the hook, as it was in 2008, because banking is borderless; Australia’s banks get 30% of their funds from Europe, but money there is being rationed and the price has gone up.

American companies have huge exposure to Europe, and more and more of them are now warning investors that sales are suffering.

There is a fantasy doing the rounds that EMU will work if only there would be a fiscal union as well, with eurobonds financing national deficits and a real central bank recapitalising the banks, all funded by, um, well … Germany.

Really? Greece and Spain are going to cede their sovereignty to Germany? They would rather, I’d suggest, declare bankruptcy. The euro cannot last in its present form because the countries that make it up are too different.

For Australia this means nothing very good, apart from, perhaps, a lower currency. Interest rates will be cut further while at same time credit is rationed — there is, and will be for a while, a sort of low-interest rate credit squeeze for businesses accompanied by reduced demand for household mortgages.

As discussed here on Monday, there is a long-term bubble in safe assets keeping bond yields low, and a structural bear market in risk assets. Neither of these things will end in a hurry.

*This article was first published at Business Spectator

Peter Fray

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