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For some
time I have taken the view that rescuing eurozone
governments from their financial crises was too big a job for the European Central
Bank, which should stick to keeping the banking system going. The only hope
was that individual governments would be forced to face up to the reality of
cutting government spending hard and quickly. They have failed to even begin
to address this fundamental problem. As a consequence, it is now impossible
for them to roll over their maturing debt, let alone raise new money. Instead
there is now a scramble into cash as banks and hedge funds prepare themselves
for sovereign defaults.
Posturing
over geared stability funds, financial transaction taxes, installing
unelected governments, putative treaty changes and finally enhanced fiscal
supervision proposals have finally convinced markets that the only outcome is
widespread government defaults. There is now no alternative and the fallout
will have to be managed.
The inept
handling of this crisis has weakened the eurozone’s
banks to the point that they are unable to subscribe for more debt.
Furthermore, the ECB cannot afford to see the liquidity it provides to
European banks disappear into new government bonds that will default anyway.
Therefore, it is now in the ECB’s interest to see sovereign defaults
occur as soon as possible, unless the International Monetary Fund can come to
the rescue, which is looking less likely by the day.
There is
growing evidence that there is insufficient support for an IMF bailout from
its member governments. The IMF’s charter is as an intergovernmental
lender of last resort, not a supporter of government profligacy. Following the
failure of the G20 meeting in mid-October there has been no substantive
attempt to rescue the eurozone. The telephones
might be buzzing, but there is no urgent meeting, suggesting that events must
take their course.
So the
quicker these defaults happen, the sooner the ECB can work with the national
central banks to bail out the major Eurozone commercial banks. Once we accept
this line of reasoning, we must think about the likely candidates. In no
particular order they are France, Italy and Greece: France and Italy because
they have to roll enormous amounts of debt in the coming months and Greece
for obvious reasons. Less pressing perhaps but also likely default candidates
are Belgium, Spain, Portugal and Ireland: Belgium might fall with France and
the others have the potential to struggle through but might chose to wipe the
slate clean. And when the first goes, the rest will surely follow rapidly.
The
sequence of events is now under way. This will be followed by the defaults
themselves, and the likely trigger will be escalating French government bond
yields.
In summary,
we have reached the point where the ECB’s vested interest requires eurozone governments to default because further delay
will make the rescue of the currency and banking system more difficult.
Expect co-ordination between the Bank for International Settlements, The Fed,
Bank of England and Bank of Japan to smooth markets through the turmoil and
to back up the ECB.
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