In Case of Euro Crisis, Break Deutsche Mark Glass: Mark Gilbert
Juergen Stark keeps a framed sheet of deutsche marks bearing his signature on his office wall at the European Central Bank in Frankfurt. He should consider adding a sign saying “In Case of Emergency, Break Glass.”
The rescue package cobbled together to prevent Greece from defaulting has trashed investor confidence in the common currency project. I hope the Bundesbank, where Stark learned the craft of central banking before joining the ECB’s board, has a locked safe somewhere in the basement containing a blueprint for a euro exit strategy.
The “New Normal,” as the bond mavens at Pacific Investment Management Co. have dubbed the post-credit crisis environment, turns out to be a world where scenarios move from impossible to inevitable without even pausing at improbable. Flocks of black swans go winging by with a frequency that is dulling our sensitivity to just how extraordinary these financial times are. Call it crisis fatigue.
The next market earthquake -- a derivatives black hole in the accounts of a big bank, a failed government bond auction by a euro member, war in Korea, a hedge fund relearning the lesson that markets can remain irrational longer than you can stay solvent -- poses bigger risks than usual. Not only is the universe of money more dysfunctional than ever, policy makers are almost out of ammunition and ideas.
Unbelievable Truths
The new normal is decidedly weird. Consider your likely response if I had bet you three years ago that the following would come to pass: many of the world’s biggest banks are state- controlled; a global tax on securities trading looks inevitable; the financial industry is hooked on central bank liquidity, with firms still unwilling to lend to each other; the corporate bond market is shut; policy makers have resorted to buying government debt to cap surging borrowing costs; some nations are unable to borrow at all; and Germany wants to ban some sovereign credit- default swap trades to divert the spotlight away from the spreading collapse in government creditworthiness.
The money markets are dying as the financial community decides it’s safer to recycle tarnished debt for cash via the central banks rather than risk lending and borrowing with the institution next door.
Transactions between U.S. commercial banks have slumped to about $162 billion from a peak of $494 billion in September 2008, the month that Lehman Brothers Holdings Inc. filed for bankruptcy protection. The ECB said last week it expects European banks to have even bigger loan losses this year than in 2009.
Transfusion Confusion
The new normal makes the Federal Reserve and the ECB the lenders of first resort. There’s no way central banks can switch off their life-support machines while the money markets are still a heartbeat away from flat-lining.
The ECB said this week it now owns 40.5 billion euros ($48 billion) of euro government bonds. Trouble is, there’s no transparency about what it has bought. Government money distorts the information channel that is supposed to flow from open- market prices. Why would I risk buying Greek debt if the deep pockets of a central bank are soaking up Spanish bonds, or adding to my Portuguese investments when it might be hoovering up Irish securities?
So, Germany’s borrowing costs have dropped to a record as investors seek the safety of bunds. Everyone else, though, is getting hammered, as contagion infects the core members of the euro region as well as the so-called peripheral borrowers. Government would do well to remember that money managers are under no obligation to lend to them by buying their bonds.
Seas of Debt
France, AAA rated and shoulder-to-shoulder with Germany when the euro was being created, pays about 55 basis points more than its Teutonic neighbor to borrow for 10 years, triple the average spread in the past five years. Spanish 10-year yields have soared to 4.66 percent, higher than they were before the European Union set up its 750 billion-euro aid package.
The EU lifeboat, called the European Financial Stability Facility, will sell bonds guaranteed by the euro members if a nation requests aid. If you told your grandmother that the solution to too much debt was to borrow more, you’d get a well- deserved spanking.
It’s also the Bundesbank’s worst nightmare come true. Joint and several bond issuance was supposed to be outlawed by the euro’s bylaws, to prevent the profligate from hitching a free ride on the backs of the fiscally disciplined.
Breaking the Piggybank
Bondholders aren’t the only sufferers. Equity investors should also beware, because every profitable industry will start to look like a piggybank to governments anxious to raise revenue wherever they can. Australia’s tax on mining companies and Germany’s move to impose levies on banks, air travel and nuclear-power plants are just the beginning. And the global authorities are only just embarking on their efforts to increase banking regulation; do you really want to bet against the law of unintended consequences kicking in good and hard?
After unleashing Keynesian pump-priming of unprecedented proportions, governments are about to try a second never- attempted-before experiment, as they struggle to tighten their belts even while trying to clamber out of recession.
“Time, devaluations and debt restructurings might be the only way out for many nations,” Anthony Crescenzi at Pimco, which runs the world’s biggest bond fund, said in a research note. Printing money to resuscitate the economy is “a magic elixir that has morphed into poison,” he wrote.
Instead of handing out euros to bail out its neighbors, maybe the Bundesbank should warm up the printing press and prepare to start stamping out deutsche marks to replace those devalued euros.
Mark Gilbert, author of “Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable,” is the London bureau chief and a columnist for Bloomberg News. The opinions expressed are his own.)
To contact the writer of this column: Mark Gilbert in London at magilbert@bloomberg.net
To contact the editor responsible for this column: James Greiff at jgreiff@bloomberg.net
Rate These Stories
Rate this Page