Guest post. Translated from the French by Tim Gupwell
In the little game of who won and who lost, what conclusions can be drawn from the recent European council? Interpretations differ widely: some highlight the German Government’s about-turn, who themselves retort that the essence of their position has been preserved intact; others congratulate Mario Monti for his skilful manoeuvring; while the French claim that the real winner is Europe itself, magnanimously playing the role of victor, and giving credence to the idea that the Germans gave in. With everybody trying to turn the situation to their advantage, where does the truth lie?
1. If a bit of breathing space has been created, the fundamental strategy remains unchanged, symbolized by the fiscal pact which it is based upon. François Hollande has announced that he will now propose it for ratification by parliament, setting aside his reservations. The priority is still debt-reduction; nothing has changed on this front. At the same time, a queue is forming of those hoping to take advantage of the breathing space which has been created, , consisting predominantly of the Spanish and the Italians, but also of the Greeks, the Irish and the Portuguese. There are many of them and there remains a lot to be done! The aim will be to prevent the breach which has already been opened up from growing any larger, the ultimate sanction being that the EFSF and ESM funds will run out. As a precaution, an insurance mechanism designed to make them go further is being worked on.
2. After a return to budgetary virtue, the protection of future generations, and a new growth package, a new diversion tactic has been put into place, which will allow the debt-reduction to continue at a yet to be determined rhythm. It is assumed that the root cause of the crisis is the fact that the European project has not yet been completed, and that this therefore needs to be remedied. The union will be in four components, the key terms of the progression whose development is far from guaranteed because of a backdrop of persistent disagreements, and which the Euro group ministers are going to start looking into on the 9th July. The markets are likely to blow hot and cold, something which has in fact already started. What is essential is to not get bogged down by the unwieldy procedure of a revision of the treaties and to reduce democratic ratification to the bare minimum. It is highly unlikely in this respect that the use of referendums will be privileged…..
3. Additional time has been granted for debt repayment, as a result of refinancing measures which depend for the most part on the States and the ECB (in which they are the shareholders). The idea is that the only thing needed for everything to fall back into place is extra time, and not dwelling on deadlines. But is this really so sure?
The new set of measures dodge one crucial issue which has been carefully put to one side: can the financial system be repaired, and at what cost? However, everything that we observe in this domain should give us cause for reflection. There is every sign that the crisis of confidence is spreading rather than being contained, a supreme irony for a world which craves confidence and which has never stopped wanting to bring it back whenever it starts to disappear. However, as we contemplate the scene of the crime, it seems to be entirely absent.
Let us look at this in a bit more detail. The European banks continue to lack confidence in each other, leading to an interbank market which is limping along even on better days, only propped up by the ECB. The American mutual funds do not seem to trust them either, reducing their dollar exposure whenever they can, with the ECB taking their place and supplying them with dollars thanks to swap agreements concluded with the Fed. The market is no longer functioning as it should.
These same banks also lack confidence in the prospect of their loans to the states being reimbursed, having had their fingers burnt by the Greek debt restructuring, and wondering if it will be possible to avoid another similar experience. New uncertainties in the bond market are undermining, in the short term, what had formerly been the lynchpin of the financial world, as well as creating great incertitude about its longer term prospects, even for what are currently considered as safe havens, American, Japanese, British and German bonds. Investors are doing the same thing to the banks, causing an unprecedented depreciation in the value of their share capital which expresses at the very least a strong loss of confidence.
Finally, two recent episodes have had an enormous impact: firstly, J.P. Morgan Chase’s losses – not just because the bank got caught out, but because of its incapacity to measure the risk, a field in which it was supposed to excel. And yet, it is good risk evaluation which is at the source of confidence. If the former proves too complex, the latter disappears. This also explains why the banks are so mistrustful of each other, knowing as they do the artifices that they have employed to present themselves in a good light. The result is to hinder and render impossible any risk analysis of their peers.
Secondly, the manipulations of the Libor, the Euribor and the Tibor have sounded a new and even shriller alarm. If the indexes on which numerous financial transactions are based are no longer reliable, how will it be possible to restore the credibility needed for the system to function properly once again? “It is the most damaging scam I can recall” declared Andrew Tyrie, the Chairman of the Commons Treasury select committee which will hear Bob Diamond, the chief executive of Barclays. The City is in turmoil as the investigation pursues its course, watched by the whole world.
The symptoms could be listed indefinitely, including by penetrating deeply into the inner workings of the financial system, by for example evoking the problems as to the paucity or the quality of the collateral used as loan guarantees by the participants. This system has become a mine field and systemic risk is second nature to it. The reciprocal commitments and exposures are dependent upon a precarious trust, which continues to threaten the balance of the whole in a more or less subterranean manner. In addition to this there is another fundamental reason: honouring the entire debt mountain requires growth but this is currently too feeble (when it manifests itself at all). The financial system is proving to be its own worst enemy, constituting the very driving force of its own crisis.
The European authorities are adopting the same approach as a banker: they have extended the reimbursement payment schedules so as to avoid having to acknowledge the losses. But the day is coming when this will no longer be possible, given the current condition of the financial system. If this should occur, it will be in its own way a great leap into the unknown, putting the fiercest defenders of the system on an equal footing with those who consider that its time is up – without being able to come up with any ready-made replacements.