A BIG BANG, OR NOTHING , by François Leclerc

Guest post. Translated from the French by Tim Gupwell

With the G20 meeting being held in Mexico at the start of the week, our perspective will find itself altered, falsely accustomed as we are to only seeing the debt crisis from a European angle. On the 18th and 19th June, the greats of this world are going to gather in Los Cabos, a tourist resort in Southern Lower California, under the double auspices of debt and global recovery.

To avoid standing idly by whilst confronted by a disaster of its own making, the British Government has just announced a plan to relaunch the economy with banking credit, funded by a Bank of England liquidity programme. In the context of an overall 80 billion programme, there are plans for monthly injections of around 5 billion Pounds (6.1 billion Euros). But the question that needs to be asked is whether the results will be as inconclusive as those obtained from the ECB’s massive injections, or indeed the tireless pursuit of zero-rate loans (from 0% to 0.1%) by the Bank of Japan – still without any further success – and whose 700 billion Euro acquisition programme of private and corporate securities is still in force.

The British Government wants to make these banking loans conditional on the latter making specific commitments, but hasn’t this been heard before? The monetary policy instruments of the Central Banks merely allow more time to be bought, and do not resolve any of the unanswered questions.

Debt-reduction in the absence of growth is an exercise which was risky before, and has now proved to be impossible. A miracle remedy – according to those with the power to turn words into action – the harmonious union of both is advocated (with subtle differences) by everyone from the IMF to the German Government. The exercise is hopeless. In an open letter to the president of the G20, Felipe Calderon, the threat of a global recession has just been brandished by the Institute of International Finance, accompanied by an insistent demand to do something about it. In defending the development of a European plan for growth in Rome, Mario Monti and François Hollande have launched the chorus of voices which has just started.

With regard to the debt, it’s all action! The Europeans are hoping to reach an agreement to lengthen the hurried timescale which they had thoughtlessly announced. Without, however, altering the formidable mechanism they had also put in place at the same time; thus rendering this arrangement pointless for a number of countries trapped between the alternatives of exorbitant bond rates and an economic recession which eats away at their receipts and causes their banks to fail.

In the United States, questions will soon start to be asked again, once the presidential elections are over next November, taking the form once again of a possible increase in the debt ceiling – in the absence of any agreement between Republicans and Democrats on what tax changes and budgetary expenses to carry out. In Japan, to finance itself, the country is gradually edging its way towards a return to international markets, with the fear that it will be forced to agree to higher rates than those of its internal financial markets (as well as directly from its central bank or via the banking system) from which it currently benefits.

Faced with these imminent threats, a return to growth would solve many of the problems and avoid difficult decisions having to be taken in many areas. But one does not seem able to conjure it up on demand: a mystery on which it is better not to dwell on too much! Lying behind the warning from the Institute of International Finance, which has not hesitated to compare the importance of the next G20 with that of London’s in 2009, there is a glimpse of another preoccupation: that of the possibility of a next big storm occurring.

Certainly, the banks everywhere are struggling to increase their capital ratios, still burdened with assets that they have forgotten to write down, and having to face up to a reduction in their business volumes or to reductions in the scope of their activities. But what they fear above all are new sovereign debt restructurings – now they have come to understand the extent of the obstacles caused by the public debt-reduction and have become aware of their own difficulties in this field.

The separation of public and private debt has, somewhat too late, become the watch word of the supporters of the European Banking Union, but it is easier said than done once the problems are already in existence. In the United States and the United Kingdom, the central banks solved a problem which the ECB tackled by sidestepping it, perhaps herein lies the explanation. While the banks have been able to offload onto the Euro system their Greek debt, and even some of the Spanish debt, they now have to face up to a formidable problem: what kind of solid assets can replace sovereign debt which used to be classed as zero risk – whose cost remains reasonable and which do not further penalize their yields (hence discouraging the investors who they hope to attract to help reinforce them)? Already the European authorities are waving a veritable red flag to a bull at them by threatening the banks’ creditors with the possibility of having to contribute to their own rescue – then we will have seen everything!

The debt reduction crisis does not, therefore, simply boil down to a public debt crisis, as the current state of affairs in Spain has recently proved. It would be totally wrong to believe that the crisis is specific only to that country, as a result of a property bubble not experienced by other countries. Having failed to openly tackle the private debt crisis, a new magic trick is being attempted, attempting to create the illusion that a European Banking Union will be capable of sharing the management of its chaotic deleveraging at the heart of one single banking system. As if it had the means to do so…
The same problem comes up every time: the debt bubble is just too huge to be reabsorbed without causing a maelstrom of major damage. The very most which can be hoped for is that it can be contained in such a way as to prevent it from bursting.

Hence the anxiety manifested by the Institute of International Finance, calling for a relaunch to sort everything out, and who, in their desperation, see no other solution – without daring to propose it transparently – than a massive concerted intervention by the Western central banks: a monetary Big Bang. Such are the rumours on Wall Street too. Only this kind of intervention would be able to absorb the shock of new debt restructurings and the losses they would lead to. For the time being, the Americans and Japanese envisage sending “a strong message” to the Europeans, we’re not there yet…

Certainly the Europeans have a plan – at least if they can come to an agreement amongst themselves – but on top of the uncertainty surrounding Greece which looms over them, there is the bragging of Mariano Rajoy, who would like to escape from the second part of his rescue package this time. Enough to fan the flames of the fires which are smouldering in Italy, even if the German political parties have given themselves until the 29th June to reach an agreement which would allow the ratification of the ESM, whose contribution is fundamental to the financing of Spain.

Faced with a lack of any better alternatives, Mario Monti’s government is piling up the announcements. A plan for a 200 billion Euro reduction of the public debt (a debt which in all amounts to ten times this sum) is being urgently studied, intended to be staggered over three years and resulting from the sale of public assets: property or local companies belonging to the public sector. Nonetheless, the buyers have to be found from somewhere…. It is worth noting that the overall debt increased by 3 billion Euros in a single month, from March to April, in spite of a primary budget surplus. No need to look for the reasons, it is all down to the burden of the interest payments.

The pawns continue to tap on the wooden game board, whilst in Greece the game of Tavli continues… But what is the key factor in this resurgence in the European crisis? The answer is the policy defended by Angela Merkel, who criticizes the “mediocrity” of every proposal to share the risks. Preoccupied by the wave of those who wish to have the conditions of their financial aid renegotiated in the light of what the Spanish claim to have obtained, Jens Weidmann, the president of the Bundesbank, recently declared to El Pais that the Spanish bailout must be accompanied by reinforced conditions (literally, “widened conditions”), wrong footing Mariano Rajoy. Forcing things through in this way is highly destructive, and doesn’t bode well for a Franco-German compromise.