Euro Crisis: The Real Players Are Not Those You might Think

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The media would like us to believe that the Euro-zone is in the hands of Germany. After the Euro Summit of 8 and 9 December it certainly looked like it. 

Frau Merkel succeeded in  imposing her rules of the game to the whole of Europe: strict fiscal discipline and austerity. Growth that had been a French and Italian concern was firmly put on the back burner. Even firewalls to defend Euro-government in distress (including 200 billions to the IMF) have taken second place: none are at a level sufficient to defend a big economy like Italy's and they won't become operational for many more months, perhaps (in the case of the Stability Mechanism) next July at the earliest...

Still, there was a moment of enthusiasm. The media made a show of the 26 countries pulling together around Merkel's cure for the Euro while the 27th member of the Union - the UK - opted out with a flourish. Cameron claimed he vetoed Merkel's proposed amendments to the European Treaties to "protect the interests of the City" (which accounts for 10% of UK's national product).

The British bulldog is out of the European ring. The British media (see the UK Guardian article below) trumpeted that Britain can provide an "escape route" from the Euro that is collapsing, and thus "build a Europe outside the Euro". Conservatives crowed welcoming Cameron as their new hero. But City bankers and hedge fund managers begged to differ, as they now (rightly) feared that the City which needs Europe to be an active international financial center, runs the risk of becoming progressively marginalized. 

With Cameron's precipitous and ill advised move, the UK has isolated itself from the European process of anchoring its currency and building "more Europe", as Merkel grandly calls it.

So tick off the UK. Regardless of what the British say in their press, they won't matter in the Euro crisis for some time to come.

So who matters? 

This is first and foremost a financial crisis. To understand who is really pulling the strings in this show you have to look at the big financial players. And that's not the European political class, and least of all  Merkel with her time-consuming cure aimed at the wrong objective: i.e. balancing budgets rather than stimulating growth. Only with growth is there a change to increase tax revenues and eventually achieve balanced budgets in future.

The market is fast and demands instant, credible solutions. Frau Merkel is slow and offers only long-run political solutions. If she has it her way, there will be plenty of time for the Euro to crash before European treaties requiring close fiscal discipline and coordination are amended and adopted.

Because there are forces at work right now to make the Euro crash: all those speculators who have placed their bets against the Euro. And it already hurts: there's a huge credit crunch going on at this time and European banks are scrambling to shore up their reserves. The last thing they're thinking of is to lend to their clients. Clearly a recipe for disaster and depression.

In these attacks against the Euro, American credit ratings agencies are playing a key role. They always issue warnings and downgrades at the most delicate junctures, precisely when a moment of silence would be welcome. Last week was no exception: before the Euro summit, they all announced that they were putting the Euro-zone members who still enjoyed an AAA rating  "under surveillance". That means of course Germany and France. And small wonder: the German economic model, depending as it does on exports, is about to come crashing down as the recession deepens and demand for its exports collapses.

Because collapse it must. The handwriting is on the wall. The credit crunch that is paralyzing European banks is already felt in Asia, where loans and support to business acquisitions is slowed down or even frozen. If Germany cannot sell to Southern Europe on which it has imposed austerity and cannot sell to Asia because European banks have seized up, who are the Germans going to sell to? The Russians? They're facing an economic slowdown. The Americans? Come on, the Americans have still to come out of their own slow-moving recession and solve their unemployment problem...

Since the Euro crisis is exquisitely financial, it requires financial measures to solve. Not amendment to treaties. Sure, in the long run, Frau Merkel is right: close coordination of fiscal policies and measures are required for the stability of the common currency. 

But is this the "fiscal compact" Mr. Draghi expected of Euro-zone governments? Surely he cannot hope for more from the European political class. Last week they gave all they had. And each country showed how committed it was to the European ideal: both Italy and Greece have gone to great pains to adopt belt-tightening measures. On the other side,  in addition to the UK, Sweden and Hungary have also shown how little they cared about Europe. They might yet change their mind, but for the time being, they have opted out, saying they need to consult with their parliaments.

Yet the European Central Bank so far hasn't moved...much. Last week (what a week!) it has indicated to Euro-zone banks that they could consider the ECB as their lender of last resort. That's a step in the right direction. But bond buying of Euro governments in distress is still off the books: so far, the Bank has bought some 200 billions worth of bonds, one tenth of what the American Federal Reserve has done over the same period of time. In other words, the European Central Bank is still toeing the German Bundesbank line of refusing any "quantitative easing". That's the fashionable term for resorting to the money printing press and it is something the Germans won't hear about, in the misplaced fear that this could cause some sort of hyper-inflation. Germans are obsessing over the hyperinflation they suffered in the 1920s and that brought Hitler into power. 

But times have changed! If anything, we're headed towards deflation - and even the Fed's generous quantitative easing has not had any noticeable inflationary impact...

Add to the mix the role of the American credit rating agencies, and you have a recipe for disaster.

The solution? Two major steps, one easy, the other not.

1. The European Central Bank should act as a central bank normally does, and engage in quantitative easing as appropriate and whenever needed; that's the easy step: once the ECB pulls out its bazooka, speculators will scramble for their lives...

2. American credit agencies should be taken off the books of whatever Euro-zone government structures where their rating is still used as a reference for investment (usually pension funds). This is something that is already proposed by America's banking regulators: that all references to credit rating agencies should be removed from regulations and be replaced with a formula based on a company's cash flow, leverage and volatility of its stock price to assess the riskiness of corporate debt. American banks have until February 2012 to comment on the new proposal before final rules are issued by the competent Federal authorities (the Federal Reserve, the FDIC and OCC).

Likewise, Europe should move forward on this chapter and a new Euro-zone credit agency should be created to substitute for the American ratings agencies, since they are even discredited in their own country. Of course this is not an easy step - the Chinese have already done so and created their own agency but it certainly hasn't yet attained the required credibility to be effective beyond China -. The process is undoubtedly delicate and time-consuming and complex (like Merkel's cure for the Euro). Nevertheless, it should be started. 

It makes no sense that the Euro-zone economic well-being should be in the hands of American credit agencies (whose customers are the speculators attacking the Euro). And it makes no sense that the Euro-zone has a common currency that no one, and least of all the European Central Bank, is willing to protect...
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